Disposition effect reveals Gen X investors are getting antsy for retirement
By Paul Nixon Head of Behavioural Finance at Momentum Investments
While you may be forgiven for believing that Generation X still represents the ambitions of youth, it may be shocking to find out that the youngest Gen X person living today is now 42 years old. Every generation brings with it a certain behaviour that defines it, and this changes as they get older.
In the world of share trading this defining behaviour for Gen X appears to be loss aversion. This is a behavioural finance anomaly in which investors tend to sell assets that have increased in value, while keeping assets that have lost value. Because we fear the regret of a winning position turning into a losing one, we tend to miss out on gains by selling winners too quickly when stock prices are rising. When they’re falling, we avoid losses like the plague because they hurt – they hurt our pocket as well as our ego and so we hang on to losers for far too long and often these losers end up losing even more value.
According to Paul Nixon, Head of Behavioural Finance at Momentum Investment, Gen X investors provide an interesting anomaly when it comes to this behavioural phenomenon.
“When Covid became our new reality, their disposition effect increased to a whopping 3.92 – way above Baby Boomers, Millennials and even Generation Z,” says Nixon. “This means nearly 4 trades are happening in a winning position for each every trade in a losing position. Said differently over 80% of their trades were in a winning position and less than 20% were in a losing position – they were extremely loss averse.”
What do we do with this information? Nixon highlights that there is plenty of research out there that shows a good way to limit the disposition effect is through stop losses. “Stop losses are a form of psychological insurance. By doing this you are setting a rule before your emotions take over to understand what the limit is to the losses you will accept. When the price of a stock decreases to say 90% of what you paid for it, the stop loss triggers and you exit the position. This limits emotional trading based off fear that usually incurs a behaviour tax.”
As a generation, Nixon says Gen X is now one that is heavily focused on retirement. Considering the oldest Gen X person is now 58 and approaching retirement, that part of their journey becomes top of mind.
“Share trading is an important wealth creation mechanism but often traders can also benefit from a professional stockbroking portfolio manager to help them avoid this behaviour tax from the disposition effect. The portfolio manager is detached from the emotional state of the investor and this can be extremely valuable,” says Nixon.
With unexpected market shifts like Covid-19 and military conflicts in Europe, Nixon says, “It is easy to fall into the trap of the disposition effect. Uncertainty amplifies psychological biases. Gen Xer’s are getting to a situation where their investment decisions could have a large impact on their retirement. Getting expert advice is usually a good idea in making better investment decisions.
ENDS
