Fear and greed: how emotions impact investment decisions

Behavioural finance explores the psychological factors that drives investment decision making. Recent research points to a connection between market fluctuations and investors’ behavioural biases. In this blog, our GM Investor Relationships, Matt McHardy dives deeper into how behavioural finance works, specifically in the commercial property market, and how it may influence your decision-making.

At PMG, we rely on solid, proven investment strategy backed by decades of experience. This experience enables our experts to be finely attuned to the nuances of not only financial markets and property, but also behavioural theory and how it affects investors’ decisions.

Behavioural finance theory emerged as a response to the traditional view of finance, which assumed that all investors were rational beings who made logical decisions based on perfect information. However, real-world financial markets often exhibit anomalies that defy this assumption, so behavioural finance looks at the specific psychological influences ​and biases that affect investor behaviour.

What shapes our biases?

One of the cornerstones of behavioural finance is the concept of loss aversion. It suggests that we feel the pain of losses more intensely than the pleasure of equivalent gains. This bias is driven by fear and can lead to irrational decisions, such as holding onto losing investments for too long in the hope of a rebound.

Of course, it’s more than just fear that drives our behaviour. There are other factors equally at play.

Some examples include:

• Herding bias: Herding behaviour refers to the tendency of individuals to follow the crowd, even if it defies logic. This can result in market bubbles and crashes, as exemplified by the dot-com bubble and meme stock rise and collapse.
• Confirmation bias: People naturally seek information that confirms their pre-existing beliefs while ignoring contradictory data. In the context of investing, confirmation bias can lead to a narrow focus on information that supports an existing investment thesis, even when it may be flawed.
• Anchoring bias: Anchoring occurs when investors fixate on a specific reference point, often their purchase price or an arbitrary value, when making financial decisions. This can lead to investors selling at prices which don’t achieve maximum potential or value.
• Disposition effect: The disposition effect relates to the tendency of investors to sell assets that have increased in value, while keeping assets that have dropped in value.
• Home bias: Home bias is most prevalent in property markets (compared to equity and bond markets) and sees investors limiting their portfolio of investment in only one concentrated location.

Why is property investment such a ripe area for behavioural bias?

Research (Mahapatra et al, 2014) establishes the growing importance of behavioural influences on property investment decisions. While much of the conversation around behavioural finance has centred on stock market investing, property is a ripe area for bias, particularly in market downturns like we are seeing currently.

A few reasons for this include:

• Information availability: the property market, specifically commercial property, typically has a high dependency on intermediaries (agents), which results in more gaps between readily available information compared to other investment markets.
• Illiquidity: properties are traded infrequently relative to other asset classes, due to the physical nature and uniqueness of each asset and relatively large capital requirements.
• Lack of centralisation: property acquisition deals are typically struck during private negotiations between the parties involved, with no central exchange to monitor and track prices.

We have demonstrated that behavioural biases are built into many aspects of investing in real estate and prove a persistent threat to investors. However, the risk of biases influencing your investment decisions can be managed.

Watch the video below to learn how:

Disclaimer: The information in this blog is of a general nature and was current on 22 September. It is not intended to be regulated financial advice for the purpose of the Financial Markets Conduct Act 2013, and does not take your individual circumstances and financial situation into account. PMG does not provide financial advice. Please seek advice from a licenced financial advice provider before making any investment decisions.