Don't let your fund manager have all the fun

Sometimes I hear so-called financial experts telling young investors that they can take big risks on their investments because of youths investments.

They think that by having youths on their side, they are able to make good on any losses which they may incur. But I know from first-hand experience how painful it is to cut losses on a bad investment, even if it means losing only money which I have already made. Somehow, the pain in realising the loss is always much worse than the profit which I may have notched up in the first place. Worse, the searing experience from the loss may cause a person to become so risk averse that it skews his future decision-making.

This explains why many investors have missed out on the huge global stock market bull run following the global financial crisis six years ago. They became so risk averse after watching their investments halved in value that they would rather sit on the sidelines than make fresh forays into the market for fear of losing more money.

In hindsight, it would seem like a bad move. But at the time stock prices were plummeting as they did in early 2009, with global lender Citibank briefly sinking below US$1 at one stage, it appeared to have been the right decision. However, over a lifetime, we get confronted regularly with having to make crystal ball decisions that affect our future: Should I go to university? Is that the right house to buy? Will I be happy if I marry him or her?

In the financial sector, investors try to get around this uncertainty by hiring an army of expensive analysts to regularly issue forecasts and predictions. But the harsh truth is that nobody knows the future – not even the analysts who are paid millions to gaze into their crystal balls. Instead, all we can really do is to try to make the best decision based on the information available and hope that the outcome turns out to be right. But what gets in the way is the emotion that causes us to act irrationally as we react to the barrage of information hitting us as we make our decisions.

There are some biases which may convince us to feel more confident in our decisions than perhaps we should. One bias is what psychologists describe as the "ostrich effect". When an ostrich is scared, it buries its head in the sand to stay ignorant of the coming threat. We tend to do the same thing when it comes to investing.

When the news is bad, we tend to steer clear of everything financial – from our bank balances to our stock portfolio – and when investors behave like that on a massive scale, it can even affect how financial markets move. But when the going is good, a person can tend to become over-confident, to the extent that he might dive into investments he knows next to nothing about. And that can cause plenty of grief when the market turns bearish and he finds himself hit by huge losses.

Then there is the "procrastination" syndrome, the impulse to put off decisions which may affect your future – whether it is to start saving for your retirement, or put money aside for your children's tertiary education. The problem is that the longer you wait, the more expensive many things may get. There is also the "seer-sucker illusion", with many of us outsourcing our money-making decisions to financial advisers to try and get a better return on our investments.

But one perhaps surprising piece of advice I have for novice investors is to have fun investing their own money, rather than allowing fund managers to have all the fun by doing it for them. Overcoming the various biases requires cool-headed logic, which is easier said than done, since we have to cope with all the emotions as we react to the huge barrage of information hitting us.

I would suggest exploring the best and worst case scenarios when it comes to making an investment decision. Ask yourself what is more important – the opportunity to make a windfall, or avoid a big loss – and examine the potential outcome against your own financial situation.

A reader once wrote to me to ask how he could profitably invest the money he had saved up to pay for his wedding. He explained that there were some months before the big day and the money was idling in his bank account.

I wrote back to say that, not being fully appraised of his financial situation, I was not able to give him any investment suggestions. But it would seem to me that unless he had rich parents to bankroll his wedding dinner if the investment had gone sour, it might have been better to keep funds earmarked for events such as the wedding in hard cash.

Finding a convivial partner to share your life-long journey is one of the few things to get 100 per cent right, and you will need each other’s support and sympathy more times than you think. Jeopardising that joyful prospect in the hope of achieving some short-term financial gain seems like a ruinous proposition to me. 

Source: The Sunday Times © Singapore Press Holdings Limited. Permission required for reproduction

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