8th March was the 42nd anniversary of Douglas Adam’s “Hitchhikers Guide to the Galaxy” radio premiere. So what has this got to do with behavioural finance and investor (human) behaviour?
As it turns out, quite a lot! Panic and herd behaviour is evident. An ‘increased use’ of loo paper isn’t a side effect of the coronavirus, so relative demand isn’t increased, and supply shouldn’t really be affected here. Then why is there a run on loo paper? Social media reinforces fake news, everyone else is doing it and the media is reporting on it. Because herding behaviour is so strong, if everyone else is panicking we feel we must too. And now the shelves are empty… “See I was right!”
The analogy is evident also with investment behaviour and markets. Share markets are LARGELY efficient MOST of the time. That means that valuations are USUALLY closely priced to their reasonable value as everyone has the same information available and they will RATIONALLY apply this. However, at times it can diverge from the rational. Sometimes people are too positive (This time it’s different!!) and they discount risks. And sometimes they panic and react to everyone else panicking instead of looking at the actual valuation.
Panicking and herding are behavioural characteristics that are extremely strong biases. We do need to acknowledge them and understand that the very real, emotional reaction is normal. But then we need to stand back, look at our overall strategy, consider our buffer for these “Black Swan” events that do happen and make decisions that are best for our long-term benefits.
A good strategy manages these normal risks by having a reasonable buffer and understand that in retirement, we need to manage the income and cash-flow.
Just make sure your retirement plan doesn’t end up in the toilet because we reacted to panic!