“It’s all about context.” How many times do you hear or say that phrase?
There is no doubt that a person’s emotions, personality traits and beliefs, all bundled together as context, can complicate investment decisions. They can lead us to make bad decisions if we are not aware we have them.
Anchoring is a great example of a cognitive bias. This is where someone uses a piece of information to make subsequent judgements, but that information may in fact be irrelevant. When looking into investments, we are exposed to a lot of research, media and opinions and they can quickly anchor us to an idea.
So how in this era of information overload, do we avoid anchoring to something irrelevant? Setting up a decision framework is the first step.
Spend time figuring out the five to ten steps that you as an investor will follow each and every time you make an investment.
Ask yourself: do I understand why I’m making this investment? What’s its purpose? How much risk am I prepared to take? How much money am I thinking of making from it and does this compensate for the risk I expected? What are the main decision points going forward?
Write the answers down first so that you have clarity of thought. Develop check-lists to remind yourself of what to do in different circumstances.
Investors should be really clear on why they back a particular stock and what the key milestones, triggers, or red flags are that will make them think again and change their decision.
Having this framework and checklist helps prevent people from being distracted by the daily noise, particularly if they are looking at a three to five-year investment, for example. This can help them cut through the day-to-day issues and focus on what matters.
After you’ve made an investment decision and you’ve either made or lost money, sit down and think back to your checklists and ask yourself: “What did I learn? What did I miss? What could I have done differently? What am I pleased with? What am I not pleased with?”
Use these answers to refine those checklists and your decision framework. Refine the way that you think, just as engineers and pilots refine how they do things as result of their experience. We should be doing the same. In certain circumstances, those frameworks are what will save you.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.