Paul Nixon, head of behavioural finance at Momentum Investments
Making an investment decision – like switching between different investment funds – at the
wrong time can cost you money. We call this the ‘behaviour tax’. Often when markets become turbulent (both up as well as down), we struggle to make the right decision and instead make the comfortable one of moving to what we think is a place of safety. This ‘comfortable’ decision cost investors in retirement nearly R500 million in ‘tax’ during the COVID-19 pandemic, as they sold out after the market crash and then tried to get back into markets after it recovered*.
During the pandemic, 75% of the value destroyed was from those in retirement and after the pandemic in 2023, 65% of the value eroded was from investors in retirement. Using machine learning algorithms, we confirmed that both age and the size of the investment portfolio are two of the biggest predictors of switching behaviour.
Our reaction to market movements is part of our personality or ‘factory settings’ because of how market behaviour makes us feel. Our personality is a collection of thoughts and beliefs about the way the world of investing works. We call these factory settings as research shows that approximately half of our personality can be directly traced to our inherited genetic code.
Two important personality traits or thought patterns determine these factory settings for investing and may be linked to the behaviour tax.
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The first is our preference for now compared to later. In the Stanford marshmallow experiment, kids were offered the choice to eat one marshmallow now or hold out for 10 minutes to receive a second marshmallow. This doesn’t seem long, but 10 minutes is a lifetime to a five-year-old waiting for a sugary treat. Some kids were just better than others at this game because some had different factory settings. Subsequent replications of the marshmallow experiment showed that successful kids were able to shift their attention away from the treats (like staring at the corner of the room) or distract themselves by thinking of other things. Interestingly, this refers indirectly to the concept of ‘flow’, or rather our perception of time when we are doing or thinking about things we like. The personality trait of conscientiousness refers to those of us who are naturally good at focusing on the future and reaching our goals.
The second personality trait or thought pattern is our general level of anxiety or neuroticism. Some of us are wired to worry a little more than others. Being more anxious can result in an investment choice which makes us feel better now by acting and moving our money to ‘safer’ asset classes during market turbulence. This is referred to as the action-oriented bias (just ‘do something’). This behaviour often results in the behaviour tax because inevitably, we miss the market recovery and get stuck in the wrong place at the right time when markets recover, and they always do. Having low levels of neuroticism makes us more composed in the face of uncertainty.
It is important to note that no set of personality traits is deemed better or worse. There are, however, better and worse settings for any given situation. For example, having a spontaneous and impulsive partner can mean fascinating life experiences but left unchecked (without the right plans and strategies) these same traits also may result in poor investment outcomes.
This is where self-awareness can make a difference. Incorporating the Guaranteed Annuity Portfolio (GAP) as an investment component in your retirement portfolio can improve retirement outcomes by adding much needed certainty to retirement income planning and in fact even enhance these outcomes in given circumstances. Knowing your factory settings and implementing investment strategies (like using the GAP) can be the difference between a behaviour dividend and behaviour tax.
*Source: Momentum Investments Sc-Fi report, November 2023
Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services (FSP 6406) and registered credit (NCRCP173) provider.