Outsmart technology by staying human

Cahir Gilheaney

AS an investment, technology has been helping to drive global equity performance for more than a decade. Many investors will have benefited from this either in their pension or in ISAs.

Regular readers of this column will know that there is a well-worn caveat that past performance is not a reliable guide to future performance. This week's column is not actually about investing in technology, but rather how technology may impact and influence our investment decision making.

Investors like to believe that the decisions they make are good ones, grounded in facts which have helped them reach their rational conclusion, with attention given to information of importance, and without undue influence by factors considered inconsequential.

Spoiler alert: this is not actually the case. There are a plethora of factors that have an impact on how we make decisions, whether we realise it or not. The flaws of human judgment and decision making are well documented, and there are things we can learn from them.

One such behaviour seen among investors is the tendency to hold on to investments on which they have made a loss, and to sell those that have made a profit. A canny move, one might think - after all it's not really a loss until you sell,right?

Sadly, when it comes to investment, this bias does not go hand in hand with good performance. Studies have shown that the losing investments which we continue to hold generally tend to under-perform significantly, versus the winners which were sold at a profit.

As a word of comfort to retail investors, this isn't just you: professional fund managers have difficulty in giving up under-performing investments too. It's based on some rather interesting human psychology.

Known as the ‘disposition effect', there are two factors at play here. Firstly, we are psychologically hard wired to fear loss. Loss aversion means we feel the pain of a loss more acutely than the joy of an equivalent gain. Secondly, when we are already losing, the overwhelming mental drive to turn things around is such that we find it easier to take on even more risk.

A key factor in how the disposition effect influences our decision making is which reference point we use. Usually, the investment's purchase price will be used to determine whether it is in profit or loss.

This brings us back to technology. The tech available to consumers in the investment industry has increased vastly over the last few decades bringing a myriad of benefits. However, in order to make better investment decisions, we must combine the amazing artificial intelligence we now have at our fingertips, with what we know of fundamental human behaviour, especially when it is so easy to buy and sell.

Some interesting recent research, analysing Barclays' customers' investment behaviour, has shown that the price at the time the investor last logged-in to view their investments' performance is now more significant than the purchase price in predicting the willingness of investors to sell losing positions. Even though an investment may have performed very well over a longer period, it is the short-term change since log-in that appears to dominate the decision-making.

We would suggest that the somewhat arbitrary price facilitated by frequent monitoring on an app or digital investment tool may not be the most relevant reference point for long-term investors to base their decisions. It will undoubtedly distort your perception of risk, moving it further away from the relevant long-term reality, and increase the emotional stress of short-term market movements. This is why at Barclays we aim to default to a longer period when showing returns to customers.

The next time you are tempted to review your investments, think about how this might influence the decisions you want to make. Lean in to human psychology, check your reference points and play a smarter game for long term gain.

:: Cahir Gilheaney is a wealth manager at Barclays Wealth & Investment Management in Belfast

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