Asset Class Investing
Seven Ways to Fool Yourself
By Cambridge Partners’ Managing Partner, Jacob Wolt
The philosopher Ludwig Wittgenstein once said that nothing is as difficult for people as not deceiving themselves. But while most self-delusions are relatively costless, those relating to investment can come with a hefty price tag.
Psychologists call this tendency to select facts which suit our own internal beliefs as “confirmation bias”. A related ingrained tendency, known as “hindsight bias”, involves seeing everything as obvious and predictable after the fact.
These biases, or ways of protecting our egos from reality, are evident among many investors every day and are often encouraged by the media. Here are seven common manifestations of how investors fool themselves:
1. “Everyone could see that market crash coming”. Have you noticed how people become experts after the fact? But if “everyone” could see a correction coming, why wasn’t “everyone” profiting from it? You don’t need forecasts.
2. “I only invest in ‘blue-chip’ companies.” People often gravitate to the familiar and to shares they see as ‘solid’. But a company’s profile and whether or not it is a good investment are not necessarily correlated. Better to diversify.
3. “I’m waiting for more certainty.” The emotions triggered by volatility are understandable. But acting on those emotions can be counterproductive. Uncertainty goes with investing. In the long term, discipline is rewarded.
4. “I know about this industry, so I’m going to buy the stock.” People often assume that success in investment requires specialist knowledge of a sector. But that information is usually already in the price. Trust the market instead.
5. “It was still a good call, but no-one saw this coming.” Isn’t that the point? You can rationalise a stock specific bet as much as you like, but events or external influences can conspire against you. Spread your risk instead.
6. “I’m going to restrict my portfolio to the strongest economies.” If an economy performs strongly, that will no doubt be reflected in stock prices. What moves prices is news. And news relates to the unexpected. So work with the market.
7. “OK, it was a bad idea, but I don’t want to sell at a loss.” We can put too much faith in individual stocks. And holding onto a losing bet can mean missing opportunities elsewhere. Portfolio structure is what determines performance.
This is by no means an exhaustive list. In fact, the capacity for us as human beings to delude ourselves in the world of investment is never ending.
But overcoming self-deception is not impossible. It just starts with the idea of recognising that as humans we are not wired for disciplined investing. We will always find one way or another of rationalising an emotional reaction to market events.
But that’s why even experienced investors engage advisers who know them, and who understand their circumstances, risk appetites and long-term goals. The role of that adviser is to listen to and acknowledge our very human fears, while keeping us in the plans we committed to at our most lucid and logical.
We will always try to fool ourselves. But to quote another great philosopher, the essence of self-discipline is to do the important thing rather than the urgent thing.
Our thanks to Jim Parker for his assistance in creating this article.
Nobody Told Me
For the last 30 years, I have had the opportunity to attend great seminars, training courses, conferences, and read many good books and articles. I very much enjoy my role as a financial adviser, constantly trying to learn more so I can provide better advice.
Jonathan Clements, a long-time personal finance columnist for The Wall Street Journal, is one of my favourite authors. He recently wrote an article on his website reflecting on his learnings and what he wished he had been told in his twenties, or told more loudly so he would have listened.
- A smaller home will enable you to save and invest earlier to accrue retirement income-producing assets.
- Pay off your mortgage as soon as you can. Your mortgage interest rate will typically be higher than the post-tax return from many investments.
- Watching the market doesn’t improve portfolio performance. It’s just a huge time waster.
- Nobody knows what the short-term investment performance will be. Clements wrote that one of the downsides of working as a columnist for The Wall Street Journal was that “…you hear all kinds of smart, articulate experts offering eloquent predictions of plummeting share prices and skyrocketing interest rates that – needless to say – turn out to be hopelessly, pathetically wrong.”[i]
- You will end up treasuring almost nothing you buy. Most of the stuff we buy gets thrown away. This is where millennials seem to be wiser than us baby boomers. They are more focused on experiences than possessions.
- Will our future self approve of the decisions we make today? Pondering our future self doesn’t just improve financial decisions. It can also help us make smarter choices about eating, drinking, and exercising.
- Relax, things will work out. As I meet with younger lawyers and professionals, I sometimes see a glimpse of the anxiety that I suffered in my 20s and 30s. In the early years of your career there is so much uncertainty. What sort of career, you will have? How will financial markets perform? What misfortunes might come my way? Clements encourages by saying “…if you regularly take the right steps – work hard, save part of every paycheck, resist the siren song of get-rich-quick schemes – good things should happen. It isn’t guaranteed. But it is highly likely. So, for goodness sake, fret less about the distant future, and focus more on doing the right things each and every day.”[ii]
Some great thoughts from Jonathan Clements on the Humble Dollar website. I trust one or two of his observations resonate with you.
Andrew Nuttall is an Authorised Financial Adviser with Cambridge Partners, a fee only financial advisory practice based in Christchurch. Andrew’s Disclosure Statement is available free of charge and on demand. He can be contacted at www.cambridgepartners.co.nz telephone 03 364 9119.
Autumn Update 2020
For all of us, the last four or five weeks have been like no other. The COVID-19 health crisis we have been fighting is effectively a war that has simultaneously been waged all over the globe. And, as in all wars, there have been significant human casualties.
The different containment measures many countries have employed to contain the spread of the disease have created sudden and significant shockwaves for all markets.
Our Autumn Update attempts to provide a detailed explanation about the market reaction to COVID-19. This is significantly longer than normal because the unique and complex nature of what we are experiencing, couldn’t easily be condensed into just a few paragraphs.
As the year unfolds, we look forward to continuing to update you with the progress of investment markets in, we hope, much less turbulent times.
Creating a Birds Eye View of Your Future
We might be facing an uncertain future in the next year or so. But, given how well we are doing in our fight against COVID-19, it’s fair to assume that our country’s long-term future will be very bright indeed.
But what about YOUR long-term future?
Now is a great time to sit down with your partner and spend a valuable few minutes creating a picture of how you want this to be, using this short video as a guide.