FOMO, FOLM and the psychology of investing (2024)

Investment is an emotional business. Its two primary driving forces, at least over the short term, are fear – the fear of losing money – and greed, the fear of missing out. The past few years have witnessed this phenomenon in spades and, with the kind of volatility that we have seen, investors could be forgiven if this has made them reach for the Rennies on several occasions.

What is important is to try to remove some of the emotion from investment decisions. This is, naturally, easier said than done. Humanity is essentially a pack species and moving with a crowd always brings its own comfort. Perhaps we assume, when everyone is buying, that they know something that we don’t, so we join in. By the same token, selling can quickly turn into panic.

Sometimes, of course, there are rational reasons for these moves. The sudden outbreak of Covid at the beginning of 2020 ripped up many of the plans and forecasts that people had made for the early 2020s and we are, to some extent, still living with the consequences of actions taken at that time.

In their entirely understandable desire to support the economy, more attention was paid by governments to keeping the show on the road than to the inflationary implications. The “fear” of economic collapse was replaced by the “greed” of wanting to participate in the boom as economies reopened.

The invasion of Ukraine led to a further boost to prices and central banks, wrongfooted by the inflationary pressures building in the economy, began to raise interest rates to peaks not seen since before the financial crisis of the mid-2000s.

Cue a collapse in bond prices as the idea of lending money to any government for 10 years for less than 1pc a year, as investors had been until that point, suddenly looked extremely unattractive. As the “risk-free” returns on government bonds soared, the relative appeal of all other asset types fell sharply. Fear was once again in the ascendancy.

Towards the end of 2023 economic data indicated that inflation was coming under control, easing the upward pressure on interest rates and leaving investors looking to the sunlit days ahead when interest rates would begin to fall and all would be well in the world again. Markets rallied sharply as investors, fearful of missing out, positioned themselves early for the expected rally.

What lessons can investors learn from all of this?

Firstly, remember that markets look forwards not backwards and that the future is essentially unknowable. Like the Ghost of Christmas Future, analysts and forecasters can only show you a world that might be, not one that will be. This, in part, explains some of the volatility that you see in markets as these expectations of the future can turn on a sixpence with unexpected events such as Covid and Ukraine.

Secondly, focus on the quality of investments. Good-quality businesses have an inherent survivability to them; they tend to have stronger finances and robust business models.

Does this mean they will never go down? Not at all.

However, when times are tough the sun still comes up and most consumers don’t really change how much Marmite they put on their toast in the morning. As in the property market, when prices turn, it tends to be the biggest and best companies that lead the recovery.

Thirdly, remember the time frame for your investment. If you are looking to make a quick buck, that is speculation, not investment, and history is replete with sudden market falls that can be painful.

As the adage reminds us, it isn’t so much a question of timing the market but rather time in the market that counts. Contrary to popular belief, markets do not always go up and roughly one year in five will produce negative returns.

What matters is that your investments are worth what you need them to be worth when you need them. A suitable timeframe gives you time for your investments to recover to their previous value.

Lastly, and most importantly, in the immortal words of Corporal Jones from Dad’s Army, don’t panic. This is easy to say, of course, and unfortunately investment composure is not available in cans just yet.

Nevertheless, if you have followed the previous steps, there really is no need to panic. You have the quality investments and you have the time for their value to recover.

This works both ways, of course. Don’t feel that when markets have risen quickly, as they have recently, you have to “panic buy” and plunge your life’s savings into the stock market. There are enough reasons to feel sceptical that everything will go entirely according to plan this year – and that is just the things that we can see could potentially happen, never mind those rogue events that from time to time derail us!

Nevertheless, a well diversified portfolio of stocks has, over longer periods, produced solid returns that have beaten most other asset types, even if these returns do not move in straight lines upwards. There are inevitably years of poorer returns but, as spring follows winter, the economic cycle turns and better times arrive.

Add in some of the technological changes that we have lived through this century and our lives, businesses and the world have all changed and evolved, but these fundamental drivers of investment performance have remained pretty constant. As Warren Buffett observed, be fearful when others are greedy and be greedy only when others are fearful.

Rob Burgeman is an investment manager at RBC Brewin Dolphin, the wealth manager