Look in an investment magazine or the money section of a weekend newspaper, and you'll see plenty of suggestions for things to invest in.
The ideas are often based on trends or themes that appear to be gathering momentum. It might, for instance, be plant-based meat alternatives or driverless cars, and the reasons for investing always seem so plausible.
Other investment ideas are billed as diversifiers, with risks that aren’t correlated with those of equities, but which offer the potential for higher returns than cash or bonds.
But it’s vitally important, when you read articles such as these, to slow down and look at the bigger picture before investing your hard-earned money.
There are several reasons why investors are naturally drawn to themes and trends, and most are related to the way the human brain has evolved over hundreds of thousands of years. For instance, we tend to look for patterns, even where none exists.
We’re also highly influenced by what those around us are doing; for example, if a friend or colleague has made a small killing on a particular investment, we’re far more likely to invest ourselves.
But there are two behavioural biases in particular that make the latest investing fads seem so appealing — overconfidence and narrative bias.
Overconfidence
Humans are prone to overconfidence. It’s a trait that helped our ancestors secure resources, mates and social standing. But it can land us in serious trouble in investing.
Investors often make the mistake of assuming that they’re relatively sophisticated. They think they know more than they do. But the financial markets, and the combination of factors that cause them to move up and down, are much more complex than people realise. The evidence suggests that most investors lack even the most basic knowledge of different investments.
In February 2024, Morningstar published a report called Investor Interest in Trendy Asset Classes. (1) As part of the research, investors were asked about trends such as commodities, cryptocurrencies, private equity and private credit. For most of the assets included in the survey, fewer than half of respondents felt they could even pick out the correct definition from a list.
Investors were then asked about their motivations for making changes to their future investments in each of those assets. The most common reasons people gave were the desire for better returns, their belief in the long-term viability of the asset, macroeconomic factors they thought could affect the asset, and wanting to time the market.
In other words, investors overwhelmingly showed classic signs of overconfidence.
Narrative bias
The other behavioural bias that significantly contributes to investors’ interest in trends and themes is narrative bias. Humans have always communicated through story-telling. Why? Because stories are very powerful. They can influence beliefs, attitudes and behaviours in profound ways.
Investors will often look into investing in something because they’re read about it in the media or in an article distributed by an online broker or investment platform. The reasons for investing often seem very compelling, and people feel emboldened to invest on the strength of them. The growth of social media and the popularity of smartphones have only exacerbated this tendency for investors to rely on narratives.
It must be said, there are some excellent financial journalists, and there is plenty of useful information for investors online. The problem is that the content that is genuinely helpful and free from bias is buried inside a tsunami of noise and opinions that really don’t matter.
You should also bear in mind that even if the narrative turns out to be correct, you could still lose money. In 1998-99 for example, investment experts who predicted that the internet would dramatically change our lives were absolutely right. But people who invested in internet companies around that time had their fingers badly burned in the dotcom crash. There are many similar examples throughout financial history: good ideas often make bad investments.
Tips for Investors
What, then, can investors do to reduce the risk of being persuaded to invest in a trendy theme or asset class and later regretting it? Here are some suggestions:
1. Take time out
When we’re excited about investing in something, the temptation is to act straight away, but it’s a very bad idea. Consciously take some time to think, research your options carefully and ensure you aren’t being influenced by unhelpful cognitive biases. At the very least, sleep on it.
2. Know what you don’t know
Don’t assume you’re a better-than-average investor. Remember, the financial markets are highly efficient and ruthlessly competitive. For every buyer there’s a seller, and vice versa. Always ask yourself: Who is the person on the other side of the trade you are thinking of making? The chances are that it’s a professional investor with far more knowledge and skill than you.
3. Diversify your information sources
Don’t just diversify your portfolio — diversify the sources of information you refer to when making an investment decision. Beware, financial journalists like to read about trendy investment because they come with a ready-made narrative. So think about why journalists and other commentators write and say the things they do. Separate news from opinion. Ask yourself whether a certain piece of information is anything more than noise. And actively seek out information that conflicts with any opinions you may have formed.
4. Examine your motivations
If you’re tempted to invest in something, examine your motivations and whether or not they’re valid. For example, are you choosing to invest in something just because it’s easy to or because a new product or trading app has just been launched? Are you worried about missing out on stellar returns? Or do you just fancy a bit of a flutter?
5. Speak to a financial adviser
Before making an important investment decision, you should always seek professional advice. If you don’t understand a particular investment, ask an adviser to explain it to you and to set out the pros and cons. If you think you want to invest in something, ask them to play devil’s advocate and give you reasons for not investing.
Remember, just because it's a trend, that doesn’t make it your friend.
If you’re thinking about investing in a particular theme, take a look at Episode 22 of The Investing Show in which Jeffrey Ptak, the Chief Ratings Officer at Morningstar, explains some of the pitfalls of thematic investing.
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
Robin Powell is a journalist, author and editor of The Evidence-Based Investor.
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