With the recent market volatility, I thought this would be a suitable time to reflect upon another terrific book written by author, Daniel Crosby. Today more than ever, one may argue investors need a realistic understanding of their strengths and weaknesses, as well as concrete advice for magnifying the former and minimizing the latter. While awareness of strengths and weaknesses is helpful, for all of us we still face an interesting paradox when it comes to investing.
Paradox of investing:
- You must invest in risk assets if you are to survive.
- You are psychologically ill-equipped to invest in risk assets.
Imagine a world where you could gain more knowledge by reading fewer books, see more of the world by minimizing travel and get more fit by doing less exercise. This does not work but with investing doing less is usually best and a lesson learned is to do less than we think we should.
This concept of doing less was tested by a group of researchers who examined the behavior of soccer goalies when faced stopping a penalty kick. By examining 311 kicks, they found goalies dove dramatically to the right or left side of the goal 94% of the time. The kicks were divided equally with a third left, a third right and third in the middle. This being the case if the goalie stayed in the center of the goal, they had a 60% chance of stopping the ball; far greater than odds of going left or right.
Why do they do this? If a game is on the line for national integrity you want to look as though you are making a heroic effort, probabilities be damned. Either way, we can certainly relate and completely comprehend the actions by the goalies. This is a bias that often impacts investors as well, action bias. In life when things are happening which include accounts going down in value, we feel as though we must do something and not just sit tight and wait for things to improve. Interestingly enough, studies below show the opposite of action bias is often in our best interests:
- Best performers of investment accounts Fidelity research showed they had forgotten about them, or the account holder had passed away.
- Vanguard’s research examined performance of accounts that made no changes versus those who made tweaks. “no change” condition handily outperformed the tinkerers.
- Sweden research by Meir Statman showed the heaviest traders lose 4% to trading costs and poor timing annually.
While the concept of wisdom of the crowd is helpful when selecting a meal because it is a decision made frequently and results are instant. The crowd gets it all wrong with investing in the stock market. They enter at a time of immediate pleasure and long-term pain (bull markets) and leave at a time of immediate pain and long-term pleasure (bear markets).
Crosby references Nobel Prize winning economist, Richard Thaler who identifies four reasons making decisions can be difficult in any field:
- We see the benefits now the costs later.
- The decision is made infrequently.
- The feedback is not immediate.
- The language is not clear.
In conclusion, be aware of your own biases, create a system of checks and balances and be mindful of when and why you are making a decision. When you might have that urge to feel like you need to do something remember our old friend below.
“Never underestimate the power of doing nothing.” Winnie the Pooh