To tackle this bias, investors need to become more comfortable with the downside risks of EM investing. One way to do this is to consider EM investments as part of one’s overall portfolio, rather than just looking at them in isolation. Riskier equities may seem less like isolated gambles when they’re considered in a broader portfolio diversification context, given that they aren’t usually perfectly correlated with other assets.
In addition, it can also help to extend the time horizon over which one evaluates performance so that it matches up with the horizon of investment goals, and to evaluate portfolio performance periodically rather than continuously. While stock markets can be highly volatile over short horizons (which we’re seeing now), time tends to smooth out these fluctuations.
Personal experience biases. Finally, when investors form their preferences, or likes and dislikes, and expectations about future returns and risks, they tend to overemphasize their own past personal experiences at the expense of all available information. This barrier can be especially damaging to the portfolios of today’s younger generations, who over the past 15 years have seen two big stock market crashes and therefore may be especially apprehensive of investing in riskier assets like EMs.
The best way investors can overcome this bias: broaden the set of information that investment decisions are based on. For instance, investors should make sure they’re looking at market performance over long time periods and under different macro and market scenarios. For more on what behavioral finance has to do with – and can teach us about — investing, check out my earlier posts.
Sources: Linked to throughout the post
Nelli Oster, PhD, is a Director and Investment Strategist at BlackRock. You can read more of her posts here.