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Saturday, 11 June 2011

Self-control applies to trading too

Most individuals fall prey to emotions which can trigger the most destructive impulses in terms of fear and greed.

By Genevieve Cua


THEWEALTHIER you are, the more likely you are to over-trade on your assets, and to feel that you need more self-control. The silver lining is that as you get older, the calmer you are likely to become, and the more satisfied with your financial situation.

Barclays Wealth's latest survey of wealthy individuals throws up insights on the issue of financial self-control. This trait is undoubtedly a plus in the effort to grow and preserve one's wealth, but it is also elusive. Most individuals fall prey to emotions which can trigger the most destructive impulses in terms of fear and greed.

The survey of 2000 individuals, Risks and Rules: The Role of Control in Financial Decision Making, was released earlier this week. As it turns out, Asia's wealthy may have the most issues on self control. The region shows up prominently among the top five countries on questions that broadly reflect a penchant for risk taking.

For instance, on the belief that you have to buy and sell often to do well in markets, Malaysia, India and Hong Kong respondents were among the top five. On the statement that the respondent attempts to strategically time the markets, Malaysia and Taiwan were among the top five.

Asia Pacific respondents accounted for about a quarter of those polled. All respondents have wealth of at least one million pounds (S$2 million).

The study looks into what it calls the 'trading paradox' - that is, that those who believe in the need to trade frequently to make money also believe they trade too much. Over-active trading could make investors vulnerable to a number of biases. One is what is technically called 'narrow framing', or the failure to see the big picture. The study says that this could lead investors, for instance, to make new investments that cancel out existing ones, or decline new opportunities that look risky on their own, but may be a good addition to the overall portfolio.

A second bias is 'short-termism' which bases decisions on short time periods, when what matters is to grow wealth over a long term. For example, the MSCI World historically posts losses in about 40 per cent of the time in any given month. But over a one-year period, the probability of loss drops to 25 per cent, then to 19 per cent over five years and 7 per cent over 10 years.

The findings for Singapore were consistent with trading paradox - 41 per cent believe they have to trade frequently to make money. But at the same time, almost half wish they had more control over their financial behaviour.

While 47 per cent of Singaporeans say they are willing to bear high levels of risk to achieve high returns, 61 per cent are actually concerned with preventing bad things happening. The latter trait is based on psychological research on the motivation for doing things - either to make good things happen or to prevent bad things happening.

Says Barclays in its report: 'On the face of it, you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves, but that seems not to be the case - Trading becomes addictive. So one basic problem is that investors may feel they need to engage in active trading but they cannot then control how much they do it.'

As with other academic studies, the survey found that men tended to trade more than they should, compared to women. But it also found that having more money to trade leads one to trade too much - globally 20 per cent of those in the highest net worth category of over £pounds;10 million say they trade more than they should, compared to 14 per cent in the next wealth segment of £pounds;2-9.9 million.

Barclays also observed an increase in risk tolerance as wealth or income grows. While it might seem that greater risk taking leads to greater wealth opportunities, Barclays has this caveat: 'Our survey of high net worth individuals has picked those who risked and won; there are plenty of risk takers who have not been as astute or fortunate. In addition, for others, it may be that having a greater reserve of wealth or income creates a safety buffer which encourages risk taking.'

There are a number of self control strategies that the wealthy do use: One is to purposefully limit your options by purchasing illiquid investments. This dampens the urge to sell investments when the market is falling. A second is to use rules - spending out of income, for instance, but not capital.

The study found that the self control strategies most frequently used were the setting of deadlines to avoid procrastination; imposing a cooling off period or a waiting period before acting on a decision; and using a personal coach or adviser.

The strategies, says Barclays, have visible benefits. Those surveyed believe the strategies were effective; the most effective was the practice of setting deadlines. But there were also 'hidden benefits' as '. . . These strategies are associated with increased financial satisfaction. Not only do strategies bring this hidden benefit emotionally, (the study) also found that the strategies were associated with higher wealth levels'.

The survey found that the group with the highest strategy usage has a net worth 12 per cent higher than the group with the lowest strategy usage.

Financial advisers clearly have a role to play in guiding clients' expectations on markets and returns, and helping to temper emotional trading.

The study said advisers should make the effort to understand 'the financial personalities and objectives of their clients in order to best advise them on how to tackle market challenges, and the challenges that lie within'.

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