Self-control a challenge even for the wealthy

[Musicwhiz]

Jul 17, 2011
Self-control a challenge even for the wealthy
Those who think frequent trading would help reap more gains are also 3 times more likely than others to believe they trade too much
By Yasmine Yahya

Few investors are capable of making only the most rational financial decisions each and every time, without letting their emotions get in the way - even wealthy ones.

In fact, a recent study by wealth manager Barclays Wealth has shown that many wealthy individuals have misconceptions about investing, and feel a sense of unease over their investment activities.

According to the study, titled Risk And Rules: The Role Of Control In Financial Decision Making, many high net-worth individuals are trapped in what is known as the trading paradox.

The study had polled 2,000 individuals in 20 countries in January and February. Each had over £1 million (S$1.96 million) in investable assets and 200 had more than £10 million.

Over a third of the respondents said they believed one must trade frequently to do well in the markets. Research, however, has shown that excessive trading can compromise returns.

Yet at the same time, these individuals who believe frequent trading would reap them more gains also suspect they are overdoing it - they are three times more likely than other investors to believe they trade too much.

Barclays found that even those wealthy individuals who were aware of these biases and wanted to control them with a more disciplined approach were actually less financially satisfied.

'Rational behaviour fails us and emotions further confuse us, especially when applied to finance,' the report said.

One common mistake that investors make, Barclays said, is they tend to consider decisions in isolation, without looking at the big picture.

'We therefore tend to focus on investment decisions one by one, without considering the impact on our overall portfolio.

'This could mean we miss out on diversification opportunities, make new investments that cancel out existing ones, or decline opportunities that look too risky on their own, but would be a good addition to the overall portfolio.'

Financial advisory firm ipac's head of private clients, Ms Yash Mishra, said: 'Sometimes, it also has to do with making ad hoc investment decisions without considering implications on overall capital longevity - whether it be buying a 'hot' investment product or property, for example.'

The Barclays report also noted that people tend to base financial decisions on anticipated performance over short time periods, when what matters is growing their wealth in the long term.

Sometimes, this means they end up acting in opposition to that age-old investment strategy: buy low, sell high.

'The problem is that we tend to be comfortable when markets have been rising for a while and when we have been surrounded by good news. We are uncomfortable when we have been through times of stress and chaos,' Barclays said.

'Unfortunately this means we are likely to take on more risk when markets are high, and less when they are low.'

Certain stereotypes turn out to be rather true: Women reported a greater desire for self-control in their approach to financial management and are likely to get stressed more easily about their personal finance.

Forty-five per cent of the women polled said they wished they could take a more disciplined approach to investing, compared to 39 per cent of men.

However, it is the men who have a greater need for discipline, as they tend to be overconfident in investing, leading to lower returns, Barclays said.

ipac's Ms Mishra agreed that there are significant differences between the way men and women make investment decisions.

'In general, men tend to believe that they understand investments better, whereas women have less difficulty acknowledging that they are intimidated by financial jargon or simply lack the knowledge,' she said.

'This... results in women digging deeper in the information gathering phase and therefore getting more detailed understanding around the products and investment strategy.'

Women, being more careful and risk-averse, tend to remain prudent and place their money in asset classes with lower risk, such as fixed income securities or real estate.

Men tend to go for investments with higher risk and volatility. They are also more prone to excessive trading as they feel compelled to act on all the information they gather, Ms Mishra said.

But there are certain strategies that investors can adopt in order to exert more self-control on their financial decisions.

Grandtag Financial Consultancy, for example, helps clients come up with a long-term investment plan that can evolve over time.

'We work with the client to set a timeline so that he knows what to do at various stages of the financial plan,' said chief executive Ben Fok.

'A financial plan is not written in one day, it will evolve as we achieve certain milestones. Therefore, you need a financial adviser who can help you to navigate in your financial journey.'

Delegating one's financial decisions to a financial adviser is one of the strategies that the Barclays report recommended as a self-control strategy.

But in managing one's own finances, there are other strategies one could adopt. For example, the report advised simply avoiding information about how the market or one's portfolio is performing, in order to stick to one's long-term investment strategy.

Investors could also have a cooling-off period - after deciding on a major financial decision, wait a few months before actually executing it.

Above all, one could simply let time take its course. The Barclays study found that people do gain a sense of Zen calm with age.

'The data suggests the idea of happiness in old age also transfers to the way we approach our finances. In fact, even if wealth levels do not change, with increasing age the wealthy gained a calmness and confidence in their approach to financial management.'

yasminey@sph.com.sg