After millennia of struggling to survive against the brutality of the natural world, evolution has hardwired fear into the human brain.

Historically, it has been advantageous to assume that the mysterious rustling in the bushes is caused by an apex predator on the hunt, even though, in reality, the concealed creature often poses little to no threat.

This instinctive caution stems from our ancestors’ survival instincts, prioritising safety over certainty in the face of potential danger – it is the sense of fear. And though fear clearly serves a purpose in the human battle for survival, it can have wider ramifications on areas of your life where it is less useful.

So, with Halloween around the corner, read on to discover what fear can do to your investments.

Fear lies behind “loss aversion” and the human tendency to avoid risk

Imagine the following scenario.

A friend offers to flip a coin. If it lands on heads, they’ll pay you £20, but if it’s tails, you’ll pay them £20.

Would you take the bet?

Research shows most people wouldn’t unless the potential gain was around double the potential loss. In other words, your friend would have to offer you £40 for a win, while your risk would remain at £20.

This is known as “loss aversion”.

Loss aversion suggests that, generally, people feel the pain of losing something more intensely than the pleasure of gaining something of equal value.

While this may not sound scary in the traditional sense, the fear of loss can cause you to behave irrationally and make sub-optimal decisions.

In investing, the human tendency for loss aversion can lead you to avoid risk, keep your portfolio too conservative, and potentially fall short of the returns needed to reach your goals.

Loss aversion can also push you to sell stocks during a market downturn to avoid further losses, but doing so could cause you to miss out on future gains when the market recovers.

A drop in your portfolio’s value is just a paper loss until you sell. By holding onto your investments, you give them the potential to recover, as markets have historically trended toward growth.

The graph below illustrates how average returns dipped into negative numbers during various global crises since 1987, followed by strong rebounds in the 12 months that followed.

Source: Forbes

So, selling stocks during a market downturn may seem like the sensible choice, but historically, markets have delivered positive returns following declines.

Maintaining your investments has typically been a better strategy for success – it is your inherent fear of loss that tells you otherwise.

The fear of missing out can lead to herd mentality

The fear of missing out, or “FOMO” as it’s colloquially known, is a powerful psychological phenomenon that describes the fear of being left behind by the group or missing an opportunity that others take advantage of.

Fear of missing out speaks to our fears of social exclusion or ostracism, and it can cause feelings of anxiety and compulsive behaviour.

It can manifest in your social life, working environment, family home, and of course, in your investments.

For example, you may be tempted to invest in a particularly well-performing stock and join the bandwagon of investors who are hyping it as the next big thing. Surely, if you don’t, you risk losing out on an opportunity for gains?

However, succumbing to this fear of missing out can lead to impulsive decisions, such as compulsively purchasing stocks without conducting thorough research.

Studies indicate that this approach can be detrimental, as it often overlooks fundamental analysis and long-term investment strategies, which are crucial for making sound financial decisions.

Research by Schroders revealed that in 12 of the past 18 years, none of the top 10 performing US stocks one year made the top 10 the next year. In five of the remaining six years, only one stock did, while in one year, three stocks managed to stay in the top 10.

So, while your fear of missing out may push you into wanting to follow the hype and invest in the latest high-performer, research suggests that this isn’t likely to be a sustainable strategy.

A financial planner can help you to overcome your fears (in investing)

Fear can have practical value and could mean the difference between life and death in the natural world. However, when it comes to investing, the same feeling can lead to overly cautious behaviour or spur rash, impulsive financial decisions.

To navigate the potentially damaging effects of fear, it can be useful to cultivate a disciplined approach to investing. This includes setting clear financial goals, assessing your risk tolerance, diversifying your portfolio, and maintaining a long-term perspective.

A financial planner can help you develop a personalised plan based on this approach, which aims to assuage your investment fears and provide a clear, structured path toward your financial goals.

They can help ensure you are neither too conservative nor too impulsive in your investment choices, and that your capacity for fear is reserved for creepy crawlies, monsters, and anything else that may be lurking in the dark.

To speak to a financial planner, get in touch.

Email info@blueskyifas.co.uk or call us on 01189 876655.

Risk warnings

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.