The COVID-19 pandemic has caused much market uncertainty both locally and globally this year. Many investors choose to change their risk exposure during market uncertainty because their perception of risk has changed. But decisions made in a moment of heightened risk perception can be detrimental to achieving long-term investment goals.
“This is because risk perception is our momentary, emotional sense of how much danger we are facing. It is not an objective assessment of risk, but incorporates the psychological aspects of the investor, and results in decisions being made based on perceived rather than actual risk,” explains Marise Bester, retail distribution specialist at Allan Gray.
Bester suggests several ways which advisers can employ to help their clients to ensure that risk misperception does not lead to actions that could be detrimental to a person’s investment outcome:
|●||Be the driver of the investment, not a passenger
A study on airline pilot decision-making has shown that accidents attributable to pilot behaviour are generally due to a misdiagnosis of the risk (i.e. risk perception), rather than an overly high tolerance for risk. These accidents are prevented by improved pilot education regarding risk identification and management.The same principle applies to investment behaviour. A financial adviser plays a crucial role in providing expert insight, support and direction.
|●||Assess the probability of loss realistically
The likelihood of losing money is one of the most important drivers of perceived risk. Overestimating the probability or the extent of investment losses during market turbulence by looking at short-term risk and return measures can lead you astray.To obtain a realistic view, investors should put current events and the associated discomfort into perspective by looking at how the chosen fund(s) have responded to similar events over the long term.
|●||Accept that risk and volatility are necessary
To earn real returns, some risk need to be taken, which introduces volatility. The longer invested, the better the chances of achieving real returns.
|●||Follow your head, not your heart
Bester says it is unlikely that any risk tolerance will collapse or change drastically during market volatility. Instead, the more likely Achilles heel to be managed is risk perception. “We can positively influence our risk perception through deliberate efforts like awareness about our investment and risk management.
“If you find yourself on the verge of making a panicked decision to safeguard your investment, reflect on whether your personal circumstances, investment goals or time horizon have changed. If not, the best course of action might just be to do nothing at all,” concludes Bester, adding that individuals should also consider talking to a good, independent financial adviser for direction.
Click here to read more about research as well as a current example that showcases how investors’ risk tolerance hardly changed but their perception of risk did so – dramatically.