Caroline Ritchie
A LARGE part of my life involves research.
I read all that long, technical, jargon-esque investment stuff so that you don't have to. This week the universe drew me back to behavioural studies. They have a new name for this field now, a fancy one called Neurofinance. It aims to link brain processes to investment behaviour. It will surprise no one who has ever been an investor what these kinds of papers show. In fact, if you have walked on the earth as a human being, there will likewise be no massive revelations.
There are three main findings. To make it a bit more interesting, let's relate it all back to chocolate cake.
"People love good news about their bad habits." This is the self confirmation bias problem. It means you tend to search for and latch on to information that confirms your existing beliefs, to the detriment of that which says otherwise. When you hear "Chocolate cake lowers your blood pressure!" or "Foreign exchange trading makes you rich!" your little heart flutters. However, if you glance at the cover of Atherosclerotic Weekly and it has on it a four-layer gateau with a skull and crossbones through it, you mind scurries on, not wanting to believe. "Say it ain't so!" you brain tells you, under the influence of this powerful trait.
"This little bit can't hurt." This is the moderation fallacy. We have all grown up with this idea. Traders know the feeling. Just one little risky purchase, one more spec stock, one more day, one more week, one more year. Just one teaspoon of cake? Untenable. But one teaspoon, taken every five minutes over the whole afternoon adds up to a whopping caloric overdose. In the case of a portfolio it means a wasted collection of bottom feeders dangling false promise for years on end. You don't quit chocolate cake by switching to fudge, so don't start with the investing side of this addiction, either.
"You can always hit yourself with a smaller hammer." This one doesn't have a technical name, it's more sheer bloody-mindedness. It is obstination in the face of the facts. This is where you normally eat two whole chocolate cakes per day and completely, utterly believe that you are becoming more healthy by cutting down to one and a half. Or, you carry on holding a company when all reasonable evidence points against it. Your emotions, of course, are to blame. You've held it for years, you know the CEO, your father left it to you. The cake/stock is comforting, familiar, and, if you let it, will always be around. It also applies to poor investment advice. Sometimes, when investors receive bad advice, and it's not working, they tend to simply cut down on it when they should be chopping it off at the knees. If three out of every 10 accepted (by you) recommendations per year on your portfolio fails to perform, you are not going to heal things by only accepting six out of 10 recommendations instead. This is batting at a rhinoceros with a fly swat. You need a new advisor. Maybe the same feelings come again? I've know him for ages, he might get angry if I leave, it's just easier this way. Well, I say, use the courage of your convictions. Of course, neurofinance is in your DNA, no getting around that, so if you need some help, please ask.
Caroline Ritchie is a former AFA, sharebroker & portfolio manager. She runs Investment Stuff, a sharemarket based investment coaching service. Visit her at www.investmentstuff.co.nz This column is not personalised financial advice.