Behavioural finance

What game are you playing?

04 September 2023

Alexander Joshi, London UK, Head of Behavioural Finance

Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

Key points

  • When taking a view on what is likely to happen next with interest rates, inflation or equities, many investors are likely to search for a simple answer. However, the easy answer might be out of date or misleading. Markets, economies and politics are multi-faceted beasts. As such, focusing simply on the news that affects your own portfolio, and ignoring the rest, is probably a good start
  • Timing is crucial. The impacts of an event can differ markedly depending on when they occur, such as just how much of an impact a soaring oil price has on the global economy
  • Most news is arguably a one-day, or one-week if you are lucky, wonder for investors. For those seeking to protect and grow their wealth over many years, if not decades, then it is long-term data that is most important. Indeed, the longer funds remain invested, the more likely an investor is to make a positive return
  • An important aspect of investing success is to recognise your own individual goals and time horizon. Focusing on that, and not being seduced by the actions and behaviours of others, could be the difference between meeting your objectives or not  

As investors return from the summer break, leading economies and financial markets are facing the prospect that interest rates will likely peak soon. 

In this month’s chapter, ‘What next for equities when US rates peak?’, my colleague Dorothee Deck turns to history and looks at how stock markets, in instances when peak rates are followed by a recession, typically react. While markets in such circumstances have flatlined and then increased, this usually hides a significant dispersion in outcomes. 

This leads to the key point for this article – which forms part of our ongoing series exploring investor psychology and how to reach better investment decisions – on the importance of looking beyond the headlines and recognising the significance of nuance when investing. In particular, investors should be clear as to why they are investing – the game they are playing – and recognise the uniqueness of that in the context of market commentary. 

Making sense of the world through stories

Whether its surging interest rates, trade tensions between the US and China, or the war in Ukraine, investors are having to navigate tricky waters, and uncertainty abounds. 

During periods like this, as humans, we try and make sense of the world through stories. There tends to be a natural preference for simpler narratives. However, given the complexity of markets, the easy answer may be too much of an oversimplification. 

When individuals look back at the past, they create stories about why certain things happened, helping to make the world appear more understandable, and more explicable, in some way. However, the reality is that the world is far more uncertain than many realise. 

Additionally, history can be misleading. Not least, lessons learnt a few decades ago may be less relevant today, given structural changes in how people and businesses operate. The advent of the internet is just one example of how life now differs from that in the 1990s. 

The further back in time the data derives, the higher the likelihood that one is examining a world which no longer applies to the present day, and the more general your takeaways should be.   

As a result of the draw towards simpler narratives, the way investors behave can be driven by biases such as confirmation bias – seeking out and paying closer attention to data and stories confirming a currently held belief. Or, over-optimism – being overly optimistic about their beliefs. In a market that is driven largely by sentiment, this is particularly important to be aware of. 

It is therefore essential for investors to look beyond today’s headlines and simple narratives, and instead to the impacts of events on one’s own portfolio. 

Looking beyond the headlines

Short-term news has an initial market impact, which in turn may be reported on by financial commentators, along with second-order effects (and beyond), some of which can be counter-intuitive. The impacts of an event can also differ markedly depending on the particular time period in which they occur: for example, the degree to which the peaks in interest-rate cycles subsequently hit equity market returns in the last fifty years has varied substantially. 

Therefore, even if finding what seems to be an emerging trend (such as the increasing potential power of Artificial Intelligence (AI), as outlined in the Navigating the AI revolution chapter, it can be difficult to predict how it will affect markets. 

At the same time, these events will probably affect investors differently, based on their own investment strategies and portfolio holdings. So, one market news headline may have a variety of effects on different groups of investors. 

What they can have more confidence in, is the long-term gains that are usually earned from holding a well-diversified portfolio over many years. This is because such a strategy can provide broad exposure to companies in many sectors and geographies, across a range of asset classes, and therefore increases the chances of finding the winners from the impact of a particular development (such as AI) on the world. 

It’s also crucial that investors are clear on their own individual goals; in other words, understanding the specific game you are playing. 

What game are you playing?

Investors should be clear of their own time horizon and their own individual investment goals. 

For those seeking to protect and grow their wealth over many years, if not decades, then it is long-term data that is most important. While short-term news flow can appear to be important as it affects portfolio valuations today, much of this can be unhelpful when sticking to longer-term investment goals. For investors holding diversified portfolios, much of the news will be noise. 

The probability of seeing gains in a portfolio increases significantly as one extends the investment horizon (see chart). For a long-term investor, the odds are stacked in your favour by staying invested, through both good and the bad times (albeit nothing is guaranteed when investing).

Staying invested in equities increases the likelihood of making a gain

The changes in the probability of achieving positive returns for equities, whether on the S&P 500 or on the MSCI World, when holding them for up to 15 years

The changes in the probability of achieving positive returns for equities, on the S&P 500 or the MSCI World, when holding them for up to 15 years.

Source: Bloomberg, Barclays Private Bank, August 2023

For the long-term investor, even challenging and uncertain markets can provide opportunities. The market is likely to discriminate more between those companies performing well, and those that are not doing so well, when it comes to company fundamentals and valuations, as more clarity emerges on the outlook for the economy. This points to the attractions of actively run portfolios in what could be a fast-changing environment.

Don’t be swayed by others

Market commentaries, involving this very article, usually refer to ‘investors’ very much as one homogenous group. However, this is far from the case. Knowing the game you’re personally playing, and the one others are playing – which includes those commentating on markets – is crucial. Many are currently playing a guessing game over the likely levels and timing of peak interest rates.

For each investor, an important aspect of investing success is recognising your own individual goals and time horizon. Don’t be swayed by the actions and behaviours of others playing different games to you. 


Market Perspectives September 2023

Read our latest round-up of the global themes, trends and events currently influencing investors.