Investment Advice

Someone is sitting in the shade today because someone planted a tree a long time ago.

Warren Buffett

 

Science has changed the world in so many ways.  From medicine to engineering to the internet age that we now live in, our lives have been transformed by the real-world application of scientific research.  In the world of finance, there have also been significant breakthroughs.  Decades of research into the science of investing has yielded insightful and instructive answers to the critical question:

What investment risks are worth taking?

However, while this question now has empirically-proven answers, many people continue to take investment risks with a low probability of success.  One of the reasons for this is that we are all wired to make decisions by using our own behavioural biases. While this wiring is necessary for us to go about our daily lives, these instincts can lead to poor decision making and result in a bad investment experience.

Some examples of behavioural biases are:

  • Overconfidence – whether it is driving a car or picking stocks, believing that you are better at it than most everyone else.
  • Hindsight Bias – peaks and troughs seem obvious after the fact and we wonder why we did not see them coming.
  • Familiarity Bias – investing in what you are familiar with, giving you a false sense of control over your investments.
  • Regret avoidance – this is the “once bitten, twice shy” instinct. When we experience pain, we have a tendency to avoid the behaviour that caused that pain.
  • Self-attribution Bias – this is related to overconfidence. We tend to want to take full credit for success but blame failure on outside influences.
  • Extrapolation – this is caused by a combination of cognitive errors, where we base our decisions too heavily on recent events or we rely too heavily on certain facts, ignoring other also relevant information. If we have a bias and we find evidence to support it, we’re more likely to give weight to that data and ignore evidence to the contrary.

Understanding behavioural biases allows investors to properly identify those things which they can’t control.  These are the biases that lead us toward reducing the likelihood of success. The right discipline begins with an understanding of how markets work and allows us to focus time and effort on those things we can control to help us achieve our investment goals more efficiently and with less worry. It’s very difficult to accomplish this on your own without a good steward in your corner.

Seeking the advice of a good financial planner will ensure you are making evidence-based investment decisions rather than being influenced by behavioural biases.

Behavioural biased Investing Evidence-based Investing
Believes in successfully predicting when and how to trade based on breaking news. Understands short-term market movements are unpredictable and remains focused on the signal, ignoring the noise.
Feels a sense of urgency to make the “right” calls to beat the market. Recognises that time and patience is required for a plan to grow.
Acts on “expert” opinions (which are vulnerable to biases, blind spots and changeable conditions). Guided by peer-reviewed academic inquiry, providing grounds for steady resolve.
Defines success as outperforming others or making a lot of money. Success is defined as being able to comfortably fund personal financial goals.
Doesn’t distinguish between market risks (factors that are expected to yield extra returns) and concentrated risks (which just add more risk). Manages market risk factors and their expected returns, diversifying away concentrated risks.
Focuses on cleverly timed trades over the costs and taxes being incurred. Focuses on minimal trading, understanding that the costs involved are among the biggest drags on returns.
Tries to beat the market through clever stock-picking and market-timing. Participates in the market to earn expected long-term returns according to time-tested academic evidence, personal goals and individual risk tolerances.

 

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