A friend told me recently about how he’d finally decided to become an investor.
He had accumulated a decent amount of money for his family’s future and often grumbled as he watched inflation steadily erode its value (remember that inflation of just 2% can turn £100 into £80 in just 10 years).
Why had it taken so long for him to invest? Quite simply, it was the fear of losing money.
Unfortunately for him, that’s exactly what happened next. He invested in January at a time when the stock market had enjoyed two years of rises and was, some said, due a correction. The FTSE 100 fell more than 10 per cent from its peak within weeks of him investing.
For him, this triggered an unnerving sensation. Behavioural scientists have a name for it – “loss aversion”. This is where someone feels the pain of losing far more intensely than they feel the pleasure of gain.
Scientific studies suggest the pain can be three times more intense than the gain.
This is understandable. Evolution has hard-wired our brains to act to avoid harm – and losses.
Video explainers: The traits that may affect your investing decisions
My friend certainly felt the intensity and, perhaps, is particularly susceptible to loss aversion, which has stopped him investing earlier.
These emotions can cloud decision-making. That’s why Schroders developed a tool, the investIQ test, to let investors measure their own traits. Loss aversion, we have found, scores highly for many investors.
Once investors have identified their biases, the challenge is whether they can overcome them and just focus on the facts.
If you look at long time-frames, the UK stock market has been a good home for your money. A notional £10,000 investment in the FTSE 100 thirty years ago would be worth nearly £129,000 today, if you reinvested all the dividend income received.
Even if you factor in the effects of inflation, the figure would be nearly £51,000 in real terms.
Of course, past performance does not offer a guide to future returns, and investing isn’t for everyone. Some people prefer not to put their capital at risk, which is always the case when investing.
As for my friend, I’ve urged him to take the test before he fails as an investor at the first hurdle and makes a rash decision. At least he’ll be aware of the emotional traits that may get in the way when he’s making important decisions about his future wealth.