(Dan Kemp, Morningstar Investment Management)
It is a hard truth of investing that the biggest downside risk to the investor is themselves. While high inflation, market crashes and pandemics can all create short-term disruptions to the progress of your portfolio, the permanent damage tends to occur when we make poor investment decisions. Such decisions tend to occur when we allow our emotions to govern our actions and tend to fall into two main groups.
- The first is driven by overconfidence, optimism and a belief that recent high returns can be replicated in the future. This can lead to investors over-paying for an asset and never achieving a return as optimism evaporates and the price reverts to a more realistic lower value. The technology boom and bust at the turn of the century is probably the best-known recent example of this, however, new examples occur almost every day.
- The second is driven by fear and occurs when investors sell holdings following a crash. By doing so, they realize losses that would otherwise have been erased in a subsequent recovery. The recent experience of investing through the pandemic is a great example of this situation.
The challenge for investors is that markets are cyclical and so are the emotional pressures. Investors want to buy when prices are high and sell when they are low. Combatting these emotional pressures requires a strong investment process and the ability to think independently.
It is for this reason that many advisers recommend professional investment management for their clients and why Morningstar focuses on the quality of the investment team and the process when assessing the services of investment managers.
