Playing mind games

RESEARCHERS in the US are focusing not on investment fundamentals but investor psychology to explain the wild swings in investment markets.

At the heart of the research is the view that investment errors are caused by either over-exuberance or investor fear.

Perpetual Private Clients has identified four common examples that help to explain the bull-run of the 1990s and the doom and gloom that share markets are currently experiencing.

At the top of the list is over-confidence, which can contribute to poor risk management, such as investors pouring too much money into tech stocks.

Perpetual believes that individual investors “often give themselves far more credit, in terms of knowledge and skill, than they actually possess”.

A second common mistake is pre-conditioning, such as the misconception that current market conditions will persist forever.

“The same sort of pre-conditioning is currently occurring with views that value investing is now the dominant investment style, as opposed to growth,” Perpetual says.

The third common mistake is risk aversion.

“The most common error comes from investors who have attempted to time the market by shifting their portfolios dramatically from growth assets, such as shares and property, to more defensive assets, such as bonds and cash,” it says.

Short sightedness is another common mistake, with investors putting too much weight on recent events rather than historical trends.

For instance, many investors focus on the dramatic downturn in international share markets over the past two to three years without placing this in a longer term context.

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