Paul's Insights: How investors are overcoming analysis paralysis
As consumers we love choice. As investors, having too much choice can make us feel uncomfortable. But there is a way to overcome analysis paralysis and still build a diverse portfolio.
Behavioural science tells us that having plenty of options to pick from is a good thing. We tend to feel cheated if we don’t have a decent amount of choice.
However, an abundance of choice can be confronting. The bigger the choice, the harder it is to make a decision, and the more likely we are to stick with options we have followed in the past, or do nothing at all.
This is what psychologists refer to as the ‘paradox of choice’. When it comes to the Australian Securities Exchange (ASX), investors have a choice of over 2,000 listed entities. It’s a selection that can be especially baffling for new investors. Perhaps that’s why so many people stick to shares in a couple of the big companies. They recognise the name and trust the brand. But that doesn’t mean these stocks will be a great investment.
One way to beat the paradox of choice is to invest in the market as a whole – and yes, it can be done even if you don’t have much cash to invest.
Exchange traded funds (ETFs) typically aim to mirror a particular market index. So instead of investing directly in multiple companies, you can gain low cost exposure to the broader market through a single ETF.
A survey by the ASX shows that ETFs have become increasingly important as a low-cost way for new investors to broaden their market exposure. ETFs also came to the fore in the wake of the COVID-19 market disruption seen earlier in 2020. One in five ASX investors chose to invest a good chunk of their spare cash into ETFs following the market downturn – a move the ASX says highlights the role ETFs play in letting investors spread their money across a range of listed companies.
A good portfolio should take a mix-and-match approach. And when we are presented with an overwhelming choice – as in the case of sharemarkets, ETFs can make a decision easier. Just pick the theme you want to follow, be it Aussie shares, the IT sector and even geographic markets like US shares, and there’s likely to be at least a handful of ETFs that help you narrow down the selection.
Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.
InvestSMART offers a range of diversified portfolios that use ETFs, find out more here.