Dumb things we do
Human beings are hardwired to make poor decisions when it comes to investing. Our natural tendency is to buy at the top of the market cycle and sell at the bottom. Unfortunately, that quickly destroys wealth.
The good news is that financial planning advice can help. Advisers provide structure and discipline that can overcome our natural inclinations and emotions.
Behaviour gap
About 10 years ago, author Carl Richards released his finance book ‘The Behaviour Gap’. It explored why most of us make irrational decisions when it comes to our money. It’s not that we’re dumb. It’s that we’re hardwired to avoid pain and pursue pleasure.
And it’s why our emotions are unhelpful when it comes to dealing with the ups and downs of investment markets. After periods of strong positive returns, we feel excited and don’t want to miss out, so we buy.
Rising markets inevitably fall. After periods of negative returns, we feel fear and crave security. So, we sell.
And that’s the last thing we should do. Repeat that pattern enough times and you’ll go broke.
A better way
We should reverse the pattern. Theoretically, it’s much better to sell when markets are up and buy when markets have fallen.
Of course, that’s really hard to achieve. It’s impossible to time the peaks and troughs of investment markets.
Buy and hold
A more practical approach is to buy and hold investments over the long-run. American research house, DALBAR has proven the prudence of a long-term buy and hold approach to investing.
For more than 25 years, DALBAR has measured the benefits of the buy and hold investment strategy with its Quantitative Analysis of Investor Behaviour. According to the study, the average US share investor experienced a return of 25% lower than the US market return during the period 2016 to 2019. Poor investor behaviour cost the average investor 25% in just three years.
What this means for retirees
Unfortunately, most retirees can’t afford to buy and hold their investments over the long run. Most retirees need to sell down investments over time in order to live.
But we can sell our investments within a disciplined framework. We can compartmentalize our money and separate our long-term investments from our short-term buffer and cash reserves.
Then when we’re looking to replenish our cash buffer, we can control whether we’re selling quality assets at depressed prices. It’s much better to sell assets after they have risen in price, even if the market continues to climb.
Nobody ever went broke taking profits.
Daniel Crump is the founder of Daniel Crump Financial Planning. This article is general and does not consider your personal circumstances. If you would like advice specific to you, please visit www.danielcrumpfp.com.au or give us a call on 0418 148 622.
