An investor was telling me recently about an investment he made back in the early 1990s as a way to demonstrate his skill. Seriously … he used one example more than 20 years old to qualify his ability as an investor.
Reviewing the quality of an investment decision solely on the outcome of a single investment may be providing you incorrect feedback.
Professional poker player Annie Duke calls it “resulting” — looking at a single outcome as opposed to considering the broader spectrum of probabilities.
Often people overestimate their own skill and underestimate the role of luck in an outcome.
My point is, there’s a lot of noise in investment decisions when you only look at the outcome of one investment.
Zoom out, and consider a longer time horizon, and you see that being a repeatedly good investor is hard. That’s why so few professionals can beat the market, let alone amateur investors. There are many different investment philosophies and strategies investors use to beat the market, but there are a few skills that hold true no matter your view on investing;
Discipline
The temptation to change your strategy by dabbling in the next investment opportunity can be too tempting for those who lack discipline and get bored easily.
The Six Park investment committee meets regularly to discuss the asset allocation of portfolios. As interesting as it is to discuss geopolitics and potential fall outs, more often than not the decision is made to do nothing. And that decision takes real discipline.
Investing isn’t entertainment. The best investing is often boring.
Jack Bogle once said: “The stock market is a giant distraction to the business of investing.”
Self-awareness
We may not be aware of it, but we can be our own worst enemies. The field of behavioural economics studies how we often use mental shortcuts to form decisions. These were great to ensure that the human species survived the threats of drought, famine and predators going back thousands of years. But they don’t hold us in good stead when it comes to more modern skills such as managing an investment portfolio.
Loss aversion describes how the fear of losing something is twice as powerful as the desire to gain something. These instincts may have led many investors to sell an investment after seeing a headline predicting a market correction or crash. But that’s often the worst time. Warren Buffett says that investors are the only people who run out of the shop when things go on sale.
Confirmation bias describes how we often put the conclusion first and look for evidence to support our conclusions. In the story I mentioned earlier, my investing friend started with the conclusion that he was a good investor. He searched for evidence to support his conclusion and that’s why he so often shares the example from the 90s. He probably ‘discounts’ the many other investments that weren’t as successful.
It’s good to be humble as you won’t always be right (no one is), but you also need to be aware of how your investment decisions actually compare to a benchmark or a simple index fund. If you have no basis for comparison, you’re just guessing if you’re beating the market or not.
Patience
One of the worst things that can happen to your investor temperament is your next-door neighbour winning the lottery.
Studies have shown that neighbours of people who have won the lottery are more likely to go bankrupt in following years. It’s common to compare ourselves to others, especially when someone close to you is making money. We may find it tempting to try to keep up. Herd mentality may ensue, and we start investing like they did, and even worse… we may start buying new cars and holidays like them too.
Envy and jealousy are powerful emotions, and Bitcoin was an expensive reminder for some who didn’t want to miss out when their friends started making money.
Compounding returns are nowhere near as exciting but, year after year, decade after decade, the power of compound returns grows bigger and bigger. I believe that the rewards for never being worst far outweigh the risks for always trying to be the best. And unlike people who talk about one-off investment decisions they made decades ago, consistency is the key.
Ted Richards is Director of Business Development at online investment service Six Park and host of investment podcast The Richards Report. Six Park is one of Australia’s leading providers of automated investment management using ASX-listed ETFs. www.sixpark.com.au