A lot has happened in 2024. The pain of rising inflation has eased as the rate of price increases has slowed. This has enabled central banks to start cutting interest rates, albeit tentatively because of ongoing uncertainty both economically and politically.
Tensions in the Middle East and the war in Ukraine continue and it’s been a year of major political change, with voters in the UK, US, India and France among those who have headed to the polls. Despite the backdrop, 2024 has been a good year for investors with stock markets achieving record highs and fixed income investments delivering strong yields.
But will it continue in 2025? The challenge for next year is that central banks need to deliver on market expectations, while governments will need to deliver spending cuts as well as meeting campaign promises. Eyes are also on China and the government’s economic stimulus packages alongside the ability of companies to drive earnings growth to support valuations.
Alexander Joshi, our Head of Behavioural Finance, shares his thoughts on how to best navigate the complex investment landscape and explains how our behaviour can potentially impact investment returns. He said, “It’s crucial not only to have the right investment strategy but also to implement it effectively. Behavioural biases can alter decision-making, leading to potentially less desirable outcomes. Mitigating these biases helps investors align strategies with long-term goals.”
Key biases to be aware of
Whilst it is difficult to remove all bias when it comes to decision-making, there are things which can be done to limit the impact of biases.
We have identified three common biases:
1. Confirmation bias
This bias drives individuals to seek out and focus on information that confirms pre-existing beliefs and discounts contradictory evidence. An example would be if you only considered the good news about a stock or fund that you like and ignored any negative reports or news about it. This bias comes from an individual’s desire to be right.
For investors, confirmation bias might mean overconfidence in specific outcomes, influencing asset allocation decisions. Portfolios shaped by confirmation bias often lack diversification, increasing risk.
2. Availability heuristic also known as availability bias
People tend to overestimate the importance of events that are easily recalled, such as dramatic or emotive news they have been through before. If we can vividly remember such an event, we believe it to be more common than it actually is, which can lead to investors delaying investment decisions and holding excess cash. For others, it can lead to anxiety and impulsive behaviours like adopting herd behaviour.
3. Familiarity (home) bias
People like the familiar. Investors often prefer familiar assets, such as shares or bonds in companies based in their home market – so the UK for us, or bricks and mortar, over unfamiliar options. Similar to confirmation bias, this preference can limit diversification and expose portfolios to unnecessary risk. Familiarity also creates a false sense of control, particularly in times of uncertainty, leading investors to avoid opportunities in markets they are less familiar with, like emerging markets.
How do you overcome your biases?
1. Be careful with the news
Diversify your news sources as a first step to overcoming confirmation bias. Unbiased information helps to separate the facts from stories and narratives, as reporting designed to stir your emotions can exacerbate biases.
Keep in mind that news may be less significant to financial markets than is believed. Bear in mind the distinction between the impact on a market, and that on your portfolio. A dramatic political headline may not necessarily have much of an impact on financial markets due to a limited perceived economic impact and will likely have even less of an impact on a well-diversified portfolio.
2. Stick to your plans
It rarely makes sense to act impulsively and deviate from your long-term investment objectives. The trick is to understand the dangers of following your emotions too much, and to look beyond the short-term events influencing market returns to focus on reaching your longer-term goals. During volatile periods, investors’ emotional time horizons can shorten, as the here and now becomes the focal point. But the focus should remain on the long-term and sticking to your plan.
3. Portfolio principles
One of the best ways to reach your goals, irrespective of any behavioural challenges, is to have solid foundations in place, and allow your wealth to work for you across different market conditions.
Constructing a well-diversified portfolio that is designed to perform in various market conditions and investment scenarios is an important element of investing. By holding a mix of asset classes, sectors and regions, you can help to smooth out returns over the long term. This can also help reduce the effect emotions might have because your portfolio should be less volatile.
Following a robust investment process with a long-term focus also allows you to see through any short-term noise in the market. Noise that can derail investors from sticking to their guns. And you’ll be safe in the knowledge that your portfolio is built to protect and grow your money in the face of the events which can be unsettling.
Remember, a sensible investment approach is one that you believe in and can stick with for the long term, or to meet your long-term goals.
The case for investing
When it comes to achieving long-term goals, the case for investing and benefiting from the potential effects of growth and compounding over that time remains compelling.
As ever, the next twelve months will provide challenges, surprises and opportunities for those prepared for them and able to act on them without letting their biases get in the way.
History shows us that, through economic downturns, wars and market sell-offs, those who stick to their guns and stay invested tend to be rewarded. There are no guarantees of course. But historically some of the worst performing days have been followed by some of the best. So, if you panic and sell because share prices have fallen, you risk missing out on the recovery. It's time in the market that matters, and not timing the market.
