Can private investors learn from the professionals?

Recent share moves seem to defy logic and share prices that can move 10% or more in a day do not seem driven by rational analysis. How should investors respond? Can private investors learn from the professionals? Colin McLean, Managing Director, SVM, comments:

Emotion plays a big part in stockmarket behaviour but cannot be simply explained as greed and fear. Recognising the human factors involved can help investors manage their portfolios through these difficult times.

Psychology plays a big part in investor behaviour, and can explain much that happens day-to-day in stockmarkets. The human failings involved are not simply herd behaviour, but involve deep rooted errors of perception and judgement.

The good news for private investors is that many of these human failings are more serious for professional investment managers and bigger firms. Individuals with a single portfolio and a clear objective can actually make better decisions. Larger investment teams can easily become compromised by a desire for consensus; the best research of individual professional analysts may not be brought out in committees.

While investment experts may make fewer errors than amateurs, they often compromise their judgement by overconfidence, which can blind them to opposing views. Professionals are well placed to gather more information, but this may not actually lead to better decisions. Instead, they are often guilty of selectively picking out information that supports an initial view or prejudice. Experts are more likely to anchor their judgements in past behaviour, than to recognise a genuine change in the environment. Much of what has happened in the bank sector shows just how long it can take for a major change in prospects to be recognised. Some individuals, simply applying common sense, have been much quicker to see that the banking world has changed.

Even now - with banks not yet able to evaluate fully the likely losses from bad loans or risky investment activities - many banking analysts are still preoccupied with outdated notions of dividend yield or the ratio of share price to earnings. The flaws in those measures are now clear, yet many professionals still seem to think that last year's high share prices for banks represent some sort of benchmark of value. Common sense tells us that the crazy world of out-of-control bank growth has gone. Be wary of expert views that do not recognise this.

What should investors do? It is all too easy to be drawn into the day-to-day stockmarket turmoil, as share price volatility seems to demand action. The human mind is hard-wired to react to movement, and only later evaluates, so daily share price moves get disproportionate attention. The day-to-day noise may have little relevance to the real progress of an investment year-by-year.

Investors should plan for more share price volatility by making sure that shares represent a tolerable proportion of their total wealth. Further cash calls and rights issues from companies are likely over the next year, but investors should buy shares when they want, not when a company demands it. Dividend cuts should be expected, particularly amongst some high yielding shares where companies have high borrowings.

A good savings strategy involves other investments to counterbalance share volatility or provide ready cash. It can be more helpful to focus on portfolio totals rather than individual share prices. Savings plans should not be changed frequently. The key is for investors to keep their strategy focused on the longer term, and to ensure they are mentally prepared for short term volatility.

For more information, visit svmonline.co.uk.