Making sense of things

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

Key points

• It will be another busy, confusing news agenda for investors in 2025.
• Looking out for how your beliefs are shaping your investments, and avoiding them, is critical.
• Construct well-diversified portfolios to avoid being led astray by your emotions.
• Those that stay invested through the market booms and busts should be compensated.

The year just gone might be summed up in one word: expectations. Markets have been driven by economic expectations, central bank policy, election outcomes and geopolitical developments.

Despite a vast array of events, expected and unexpected, market performance has been strong. Equities have hit all-time highs, fixed income has delivered solid yields.

The coming year will be about delivery. Central banks need to deliver on market expectations, governments on fiscal consolidation and meeting campaign promises, China on unleashing its stimulus and companies on producing the earnings growth needed to support market valuations.

Beware of your behavioural biases

Whilst our Outlook 2025 aims to support investors with the right investment strategy and portfolio to navigate this, it is paramount to act on this in the right manner. Having solid behavioural foundations is one way to do so, allowing investors to stick to their investment plans even if the outlook gets murky.

Behavioural biases can significantly influence decision-making, often leading to sub-optimal investment outcomes. Understanding and mitigating these biases is essential for aligning investment strategies with long-term financial goals.

There are three key biases for investors to be aware of when watching the market and making decisions in the year ahead.

Key biases to be aware of

1. Confirmation bias

Confirmation bias is the tendency for people to seek out, and pay more attention to, news and stories which confirm their own pre-existing views or beliefs.

Confirmation bias can lead to a range of investment behaviours, such as influencing asset allocation decisions. Investors that have strong views on a likely outcome, which have been strengthened through confirmation bias, may select investments due to that. The result can be a portfolio which is more concentrated, and thus less diverse. 

It can also lead to overconfidence – when ones subjective confidence in our own judgments is typically greater than the objective accuracy of those judgments. One such potential result is increased trading activity. Attempting to trade around events or time the market can be costly to investors. 

2. Availability heuristic

The availability heuristic is a mental rule of thumb which leads people to assign a greater frequency to events which are more readily available in their minds. This leads to overweighting news, events and data points which can be more easily recalled, which will typically be those that are more dramatic or emotive, such as geopolitical conflict.

This can delay taking action. Investors keeping a close eye on the news, with all the potential for uncertainty and volatility, often tend to hold cash and wait before making investments. For those already holding assets, this heuristic can lead to anxiety which affects composure and satisfaction. For others it can lead to herding behaviour and momentum trades.

3.  Familiarity (home) bias

People like the familiar. When it comes to investing, investors might prefer to stick with familiar asset classes, sectors and companies. In addition, they could prefer to hold local equities or bonds, called home bias, rather than investing in a broader, more diverse, portfolio that is more in line with the global market.

Familiarity can provide a feeling of control over outcomes. Investors might attach more risk to investing abroad than is deserved, simply because overseas companies are less understood.  

Another reason is our aversion to ambiguity; situations where probabilities are unknown. Past experience can also play a role; investors may think they are better at assessing domestic assets and consequently over-estimate their judgements.

More often than not, this bias can lead to less diversification. For instance, an investor who holds most of their wealth in houses, because they know it and they are ‘real’, or someone who doesn’t invest in emerging markets, because they don’t understand it. (In ‘Adapting to the yield cycle’ we discuss the diversification benefits of emerging market debt in fixed income allocations).

Illustrating the biases

The trend for investing in anything related to artificial intelligence (AI) was displayed in 2024, and was a key driver of markets. For more on the AI boom and its potential implications, see Is AI (b)reaching its limits?

The most crowded trade over recent months was to be long the tech-heavy ‘Magnificent 7’ stocks (see chart). Questions have been asked about whether investors are being too optimistic about these companies’ prospects, as well as concerns over a small group of stocks having such a big effect on market performance. The Magnificent 7 stocks are up approximately 35% in 2024, to 28 October, significantly more than the 23% return seen on the S&P 500, of which they account for approximately 30% of the index’s valuation.

Given the importance of these stocks in the performance of the overall market this year, as well as the importance of the thematic story, given the possible wide-reaching impacts of AI, there is understandably a lot of commentary being produced. Reading much of this commentary are investors A and B. 

Investor A would describe themself as an AI evangelist. They firmly believe that AI will change every aspect of how we live and work, and has invested heavily in tech and AI stocks. They spend a lot of time reading about the potential for AI, looking for articles that confirm the importance the Magnificent 7 companies will play, and in turn, become more bullish, and increase their allocations to them.

By contrast, investor B believes AI is just a fad, and that the market is too enthusiastic about its prospects. As such, they have not invested in these seven companies, beyond their market-weighted share in existing diversified holdings. They believe that over-hyped stories about the Magnificent 7 simply confirm that the market is being too optimistic, and could be a bubble which is will soon burst. Indeed, they pay particular attention to stories about the problems facing some of the leading AI companies.

It is easy to imagine how these two investors can draw very different conclusions from the same information. When news is endless, it is also easy to imagine why each investor filters the information and seeks to align it with their pre-existing beliefs. This can exacerbate biases, and influence decision-making.

The most crowded investment trades 

Investing in the so-called Magnificent 7 stocks was the most popular trade in September and October 2024, outgunning trades in bonds, oil and gold and Chinese equities

Overcoming your biases

Whilst it is difficult, if not impossible, to de-bias yourself when living your life, or investing, there are things which can be done to try and limit their impact. We discuss three key areas:

1. Be careful with the news:   

It is important to read a variety of news sources to have exposure to a diversity of views, as a first step to overcoming confirmation bias. It’s also important to consume unbiased information, so as to separate the facts from stories and narratives. Reporting designed to stir your emotions can exacerbate your innate biases.

Investors would be wise to keep in mind that news may be less significant to financial markets than is believed. It is also important to bear in mind the distinction between the impact on a market, and that on your portfolio.  

2. Delegate to experts:  

Delegating to investment experts is one way to get exposure to markets and have your wealth working for you. Having professionals working for you, and navigating the investment landscape on your behalf, can reduce your decision-making needs, and limit the risk of biases with it. 

Importantly, experts can help you to understand your own individual goals, time horizons and broader goals. Keeping these important longer-term considerations in mind when making investment decisions, can help to make the best long-term investment calls and to ensure your portfolio holdings, and approach, remains suitable. 

3. Portfolio principles: 

One of the best ways to reach your goals, irrespective of any behavioural challenges, is to have solid foundations in place, and allow your wealth to work for you across different market conditions. 

Constructing a well-diversified portfolio that is designed to perform in various market conditions and investment scenarios is a central tenet of investing. By holding a mix of asset classes, sectors and regions, you can help to smooth out returns over the long term. This, then, also dampens out the effects emotions might have in a less-diversified, and thus more volatile, portfolio could induce. 

Following a robust investment process with a long-term focus also allows you to see through any short-term noise in the market. Noise that can derail investors from sticking to their guns. And to do so, safe in the knowledge that your portfolio is built to protect and grow your wealth in the face of the events which can be unsettling. A ‘core-satellite’ investing approach could provide the foundations to stay invested through market cycles, whilst providing the headroom for mitigating risks and capitalising on short-term opportunities. 

The best investment approach is the one that you, as an investor, can stick with, even in the face of challenges, and thus strategies which provide a degree of comfort such as a phased approach to investing, or putting hedges in place, can also be helpful. The contents of this section is summarised in the following table which can be useful when considering one’s reaction to news headlines and stories:

Reacting to the news, a framework

The case for investing

For investors who want to take a step closer to reaching their long-term goals, the case for investing in financial markets and benefiting from the potential effects of growth and compounding over that time remains compelling. 

Our Outlook 2025 explores the key risks and opportunities that we expect to occur in the year, with ideas on how a portfolio could be positioned to take account of them. As ever, the next twelve months will provide challenges, surprises and opportunities, for those prepared for them and able to act on them without letting their biases get in the way.

History shows us that, through economic downturns, wars and market sell-offs, those who participate sensibly in the markets are usually better placed to have this participation compensated.