It’s something we’re all prone to. Procrastination, indecision and uncertainty about what we should do, or which direction to take in many aspects of our lives. However, when it concerns our financial future, investment paralysis could be costly.
What is the definition of investment paralysis?
Investment paralysis is when a person is incapable of progressing with a decision as a consequence of overthinking the situation and/or over-analysing information. This type of behaviour can manifest itself when we are presented with too many options or tasks. The result of this could either mean a loss of investment growth due to non-investment or a loss in portfolio capital due to indecision in falling markets.
Key symptoms of investment paralysis
- Delaying making decisions
- Deep fear of making the wrong decision
- Forever searching for alternative or new investments
- Continuously re-analyzing existing investments
- Staying with default investments e.g default pension fund choices
Research has shown that individuals are more unlikely to act as their number of options increase. In a study on consumers, it was found that they were 10 times more likely to purchase a product when presented with fewer options. As with many things in life, keeping it simple and minimising the process can lead to greater clarity.
Side effects of investment paralysis
- Attempting to avoid investment paralysis can lead people into making rash decisions
- It can prevent you from investing anything
- It can make you feel personally responsible if a stock or fund underperforms
- On the flip-side it can make you feel terrible about high performing stocks that you’re not invested in
How to beat investment paralysis
Overall, it’s a sense of fear about making the wrong decision or just being overwhelmed by the amount of options available that leads us to investment paralysis. By taking a step back and calmly analysing the facts it can be seen that there are clear options available to us.
1. Be aware the stockmarket has a historical upward bias
Since it’s inception in 1926 through to 2019 the S&P500 index has achieved an average annual return of approximately 10%. Virtually all other indexes have the same upward bias although their returns will differ slightly.
Knowing this information can help to ease our uncertainty and indecision, because we now know that if we simply invest for the long-term our investment is virtually guaranteed to rise. The main fear of many investors though is the loss of their capital.
Warren Buffett often cites capital preservation as one of the most important aspects of investing. Nobody like to lose money, but we can be statistically certain that although the value of our investments may fluctuate over shorter periods of time, over the long run they will increase.
2. Diversify investments globally to manage risk and investment returns
It’s understandable that many people like to invest ‘close to home’ or with ‘what they know’ but history has shown us that although over the long-term there is upward bias, all regional markets ebb and flow over the medium term. If your local market has been performing well in recent times, this is no guarantee that it will continue to do so moving forward.
Japan’s Nikkei index was previously in a 30 year doldrum from the early 1990’s until 2012 when it finally started to reverse direction. If you were solely invested in this market during that time then your investment returns would have suffered substantially.
Whilst there is an element of risk associated with investing in foreign stocks or funds due to currency fluctuations or other factors, in the round there is more potential upside as a result of being able to gain exposure to their markets.
Stocks or funds in Emerging Markets have historically offered access to new fast-growing businesses and markets which have the potential for greater growth and returns than developed ones.
Equally, investments should be spread across different sectors. During the current Pandemic tech stocks such as Amazon, Netflix and Zoom have performed particularly well as people have been stuck at home. Over long time periods however, it can be difficult to predict which sectors may blossom in the future so diversifying broadly gives the best chance to benefit from growth in other markets whilst simultaneously managing risk.
If you have difficulty deciding on particularly stock or fund you can simplify the process by investing in a global index fund such as Vanguard’s FTSE All-World UCITS ETF or it’s Lifestrategy equity fund.
3. Invest in low cost index funds
Index funds have become increasingly popular in recent years and for good reason. Research has shown that on average 90% of active fund managers underperform the S&P500 index, whilst charging you significantly higher fees for the privilege which in turn erodes your investment returns.
Actively managed funds can have entry fees as high as 5% plus extra ‘performance’ fees which limit your gains. In contrast you can invest in the Vanguard S&P500 UCITS ETF for a tiny 0.07%. Vanguard’s own research has shown that fees are one of the most critical factors in overall investment returns, so keeping them as low as possible gives you a statistical advantage.
If you can’t decide what to invest in, an index also makes this easy as it automatically invests in a broad range of companies and markets. You can pick a single global fund if you cannot decide between specific funds as well.
4. Use Dollar Cost Averaging (DCA)
If you are worried about investing in the stock market during uncertain times (such as now during a Pandemic), then dollar-cost-averaging is a proven method to manage investment risk. It also keeps you invested in the markets for potential capital growth.
Simply drip feed your money into the market at set intervals such as monthly or quarterly. By doing this you achieve a favourable ‘average’ price for the share or fund. More shares will be bought when prices are lower, and less as they go higher. DCA will not completely protect you from falls in the market, but it will cushion you from them. As we now know that over the long term there is an upward bias in the markets, this is not a concern for us.
5. Contribute to a company or private pension
Making contributions to a company or private pension is the single best thing that you can do to alleviate any type of investment risk which may be causing investment paralysis. This is because pension contributions give you tax relief at your prevailing rate of income tax, plus the added benefit of company contributions if paying in to a company pension.
As one of the main fears of people is loss of capital, contributing to a pension gives you virtually worry-free downside protection of your money. In the UK you will get between 25-45% tax relief on contributions, which means that even if the market falls by this large degree, you will have not lost the initial amount you put in.
If you are getting company contributions this will give you even greater protection. Of course, a loss is only realised when we sell. As we will be holding for the long-term then this is not an issue for us as we are secure in the knowledge of upward bias in the markets. (With a pension you can not access it until you are at the required minimum age of 55 in the UK, but can buy or sell investments within the pension at any time).
The main additional reason of contributing to a private or company pension, is that the tax relief and company contributions will make a exponential difference to the size and growth of your capital through the power of compounding.
6. Be aware of the impact of inflation
Inflation generally refers to the rate of increase in prices of goods or services, and the consequent loss of purchasing power by the consumer. We notice this everyday when we buy food at the supermarket or purchase items in shops or online.
In the UK the government measures inflation through the Consumer Price Index (CPI) which monitors a basket of goods as a reference. Generally, the government and the Bank of England tries to maintain a ‘reasonable’ 2% annual target for inflation. However, as consumers we know that ‘real inflation’ is considerably higher than this when we check utility bill rises, fuel, foreign holidays or other costs.
For that reason many investors consider 5% as a more sensible figure for real inflation and seek to achieve at least that on an annual basis to protect their capital from depreciation. Knowing this, it is obvious that we cannot simply leave our money in the bank earning virtually nothing at current super-low interest rates. Investing our money in the stock market or other assets in a risk-managed way is the clear choice.