Investing through a multi-asset strategy offers benefits like diversification, but it also brings psychological drawbacks that can affect decision-making. Recognizing and addressing these psychological drawbacks is key to making informed and effective investment decisions.
In this blogpost, we’ll explore how these biases impact multi-asset investing and provide strategies to overcome them for better portfolio management.
Multi-asset investing is one of the greatest ways for diversifying an investment portfolio since money may be allocated across several asset classes such as stocks, bonds, real estate, or commodities.
Building a portfolio comprising a range of asset classes—such as stocks, bonds, real estate, commodities, and cash—each having unique risk and return characteristics is known as multi-asset investment. This diversity improves prospective returns, reduces risk, and builds a more balanced portfolio that can withstand both expansionary and recessionary times.
To reduce downside risk and even out portfolio volatility, this strategy distributes investment risk among a number of unrelated assets. In essence, this strategy buys things cheap and sells them at a premium, which is return accretive over time.
The strategy’s objective is to purchase underperforming asset classes and sell outperforming asset classes. However, the psychology of multi-asset investment is just as important as the return numbers. Humans are inconsistent beings with emotional and cognitive biases that frequently prevent us from making wise judgments on how to divide up our assets.
Some of the psychological issues that we face while adopting this multi-asset investing strategy are discussed below:
Bias to take action:
The allocation of strategic assets is often based on an individual’s investing goals, time horizon, and risk tolerance. Ideally, subsequent portfolio changes are only necessary when market activity in the corresponding asset classes causes the allocations to deviate from the desired allocation.
However, we are constantly exposed to a plethora of news and information, which prompts us to behave and respond according to how we understand events and how they affect our investments. This is frequently ineffective as one ends up with either a messy, hard-to-manage portfolio or a number of trendy investments that might not be in line with their objectives or risk tolerance. Additionally, the constant buying and selling reduces profits by raising taxes and expenditures.
Investors should develop a more methodical approach by recognizing this bias and concentrating on long-term plans and well-informed decision-making instead of giving in to the want to make moves right away.
Trying to time the market:
Market timing is the process of transferring investment capital across asset classes, in or out of a financial market using strategies for forecasting.
Investors frequently overestimate their capacity to forecast changes in the market. In a time where information and news are freely shared, the chances of an individual effectively and continuously outperforming the market are quite slim. In many cases, one waits too long to leave a losing proposal or leaves a good one too soon.
Even the most seasoned investors find it challenging to timing the market during the most favourable periods. According to a study conducted by Bank of America, investors who attempt to timing the market by getting in and out based on their own predictions may lose out on a significant opportunity. According to the study, which looks at data dating back to 1930, the overall return would be 28% if an investor missed the ten ‘highest returns’ days of the S&P 500 per decade. In contrast, the return would have been 17,715% if we had stayed invested during the different market cycles.
As it typically takes 1,100 trading days to recover losses during a bear market, remaining invested during different market periods might aid in the investing process.
This is not only true for stock markets, but also for other asset classes as well.
Loss aversion bias:
In behavioural finance, the term “loss aversion” is a phenomenon in which people believe that a possible or actual loss is more emotionally or psychologically damaging than a comparable gain. For example, the delight of obtaining Rs. 5000 will be significantly less than the grief of losing Rs. 5000.
This bias prevents us from recognizing our error and recording a loss. Because of this, we end up holding onto failing assets for longer than is prudent in the hopes that they would improve. Long-term results are adversely affected by this reluctance to declare a loss because the money may have been used to invest in possibly higher-yielding endeavours.
Many people make the error of buying the incorrect assets by either waiting for the asset price to rebound to their purchase level or going into inactivity mode. Assets with poor performance could not recover at all or might take years to recover, thereby producing poor returns.
By avoiding being emotionally invested in the assets, one can prevent loss aversion. Even while there are risks associated with investing, many of them are out of your control, and one cannot always be right. Hence, there are situations when it is preferable to admit a loss and pursue other investing possibilities.
Herd mentality:
In the context of investing, herd mentality describes the actions of investors who choose to follow the herd rather than conduct research of their own. Due to this tendency to avoid conducting our own research, we frequently follow the herd when investing in or out of assets without carefully considering the fundamentals of those assets, their suitability for our risk tolerance, and for our investment objectives. Social media and the “Fear of Missing Out,” which can result in panic selling or market bubbles, exacerbate this tendency to be nervous when others are scared and greedy when others are greedy.
By deciding to do our own research instead of relying on others to do it for us, we may strive to avoid being like everyone else. After doing your research, form your own conclusions and make your choice. Make your own inferences and inquire as to how and why others are acting in particular ways. If fear or any other outside element is causing you to become sidetracked, put off making investment decisions till you become clear of what you are doing.
Recency bias:
We often double down on our investments in an asset class that has performed well in the recent past because we believe it will continue to do so. Since no asset class can perform well over the long term, this might be dangerous and leave our portfolio open to sharp declines. On the other side, even if an asset class’s long-term prospects have improved, we prefer to steer clear of it if it has recently been in the dumps, thereby losing out on prospective strong gains.
By carefully taking into account a variety of data, including more historical ones, we may attempt to overcome this bias and obtain a more complete view of the asset class in which we are investing. Try not to rely only on recent events or facts when making investment choices or opinions.
Regardless of short-term market volatility, having an investing strategy and sticking to it is the greatest method for investors to overcome recency bias. Plan in advance when to reassess your long-term investment allocation and how and when to rebalance your portfolio. As it is frequently easier said than done, using automated investment alternatives can assist assure a hands-off approach by removing human emotion from investing decisions.
You can also check out my other blogpost on behavioural biases that investors encounter while investing.
Final Words:
In conclusion, while multi-asset investing can offer diversification and risk reduction, it’s crucial to be aware of the psychological drawbacks that can cloud investment decisions.
Multi-asset investing is a well-rounded strategy for diversifying investments and increasing wealth. By investing in several asset classes from a single portfolio, investors would be better equipped to withstand market swings, maximize returns, and feel more confident about reaching their long-term financial goals.
A multi-asset approach offers a well-balanced path to long-term success regardless of an investor’s risk tolerance, whether it be conservative or aggressive, provided we attempt to overcome the above discussed biases during the investing process by reducing human interference and emotion in investment decisions.
By understanding the above discussed psychological drawbacks and adopting a disciplined, informed approach, investors can maximize their returns and build a more resilient portfolio over time.
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