Are investment biases holding you back?

Do we as a society have an inflated opinion of our own investor ability? Do you personally have what it takes to run an investment portfolio or should you seek assistance? The answer is generally a profound – yes.

DIY investment management is on the rise in Australia but does the average DIY investor generally have the experience and ability? Some obviously do and thus manage their portfolios extremely well but without a doubt the average DIY investor (along with some professionals) will undoubtedly underperform over the long term.

There are a number of human behavioural biases and ingrained habits that in my humble opinion will forever ensure professional investment advice improves investment outcomes –

1. Confirmation bias
We seek shelter in whom/what we believe and we don’t enjoy challenging the alternative. We openly seek to find sources that support our view which often delivers poor or sub-optimal outcomes.

2. ‘Recent event’ bias
We anchor to recent biases and extrapolate recent events into the future. I.e. based on last year this will happen next year. We all know this can lead to disastrous outcomes.

3. Following the herd
We are trendy investors and struggle to accept advice to the contrary. Others doing something is not justification enough to do it as well, however it is so easy for us to ‘follow’.  Avoid the herd or be trampled by it at the exit. Appropriate advice can save us significant value over the long term.

4. Seeking comfort over smarts
Just ask Ben Graham, Warren Buffett and more recently Joel Greenblatt. Value investing works over the long term. We all know the saying ‘be fearful when others are greedy and to be greedy when others are fearful. ‘However time and time again I watch sophisticated investors make the same mistakes over and over again. We are creatures of comfort and thus we sell when fearful and buy when comfortable. This will forever be the single largest behavioural flaw of investors.

Example
Here’s a simple example as to why any human on earth needs a steadying hand to ensure they don’t make rash capital decisions. As humans we are pre-programed to run from fearful situations and seek shelter via an ingrained survival mechanism – this obviously has very detrimental investment outcomes. Long story short we run/reallocate capital and herd together at the worst possible moments!
Let’s use Netflix as an example. It has a risen approximately 6000% since 2002 however there are very few investors on earth that would have stayed the journey as it has been truly unsettling. Netflix has lost 25% of its value on a single day on four occasions (one day losing 40%) and on one month in particular it lost 80% of its value. Only the strongest willed investors with knowledge and faith in the fundamental business could have ignored the market’s gyrations and stayed true to their capital allocation. This is very hard to do without a sounding board holding you accountable to your decision to run for the exit!

5. Ignoring the mean
There is no such thing as the ‘new norm’ and please disregard anyone that suggests ‘this time it is different’. They generally say this because they are protecting self-interests. Mean reversion has a clever way of undoing momentum and supporting value. Investors don’t speculate on momentum they buy into value.

6. Overlooking risk
We do not devote enough attention to the ‘risk’ element of the risk/return paradigm and instead tend to focus solely on returns. I.e. we have a severe banking stock bias in Australia. The four banks do not constitute a diversified Australian equities portfolio, in fact it constitutes a leveraged exposure to residential Australian property. Bearing in mind we are already well and truly overweight residential property as a country!

7. Balancing a portfolio
We don’t concentrate enough on asset allocation despite it being the single largest contributor to performance. Asset class decisions are by far more important than choosing CBA over ANZ and thus our time should be devoted to building an appropriate asset allocation in line with our objectives and not what stock to buy next.  Even William Shakespeare agrees…

“Believe me no. I thank my fortune for it –
My ventures are not in one bottom trusted,
Nor to one place, nor is my whole estate
Upon the fortune of this present year.
Therefore my merchandise makes me not sad.”

In summary, investment management is a specialty area much like the other specialist providers in your life. The key is finding a well credentialed advisor you can trust that will truly lead, guide and hold you accountable to the human biases above ensuring emotions are removed and robust investment decisions made.