The other day I read an interesting piece about stupidity; why we make decisions that seemingly lack intelligence, common sense or both. I was particularly taken with the definition used for stupidity: "Stupidity is overlooking or dismissing noticeably crucial information."
This clearly has resonance when we consider investment decision making – although financial markets are awash with randomness and uncertainty, there are obvious, vital and, often simple, cues that as investors we seemingly choose to ignore or disregard. This results in poor choices and often disappointing outcomes.
We know that buying assets or funds after remarkably strong performance is typically a bad idea, yet we still do it.
We understand the challenges of short-term trading and the benefits of long-term compounding but can rarely resist the urge to react to what is happening right now.
These issues are not hidden from our view and they are paramount to our overall investment outcomes, yet we often neglect them – but why?
Here are seven factors which I think can create situations where stupidity can flourish.
1. Outside circle of competence
Economists predicting equity market moves, stock picking fund managers pontificating about macro-economics, amateur investors day trading. There are seemingly no boundaries in investment – if you are involved then you can (and must) have a view on every aspect. Investing is difficult enough without making decisions in areas where there is no evidence of anyone exhibiting consistently high returns.
If we engage with the constantly shifting narratives and random price fluctuations of financial markets, it is almost inevitable that pressure and anxiety will lead us into decisions that are damaging to our long-term goals.
The hyperbolic and frenetic reporting around financial news means we often feel the urge to act immediately. We make decisions that will make us feel good in the very short term but come with a significant long-term cost.
4. Outcome bias
The problem of outcome bias is wicked in financial markets. This is because of the characteristic level of randomness in returns particularly over short-time periods, which means sensible decisions can often appear quite the opposite. Sometimes stupidity is rewarded. Certainly not all the time.
5. Group/social unity
We often make investment decisions in a group context, and what other people are doing matters greatly to us.
6. Presence of expertise
Perhaps in no other field do we behold such an array of experts. Each offers confident forecasts and compelling trade ideas – they are intelligent and confident, surely, should we follow them? You know the answer.
7. Information overload
There is simply too much noise in investment markets. It is a struggle to work out which information is relevant (most of it is not) or how we should use it. Given the total volume of data available, our tendency is to react to it in an impulsive fashion – considering information to be relevant based on its prominence or availability.
Stupid decisions sometimes work and work enough to keep us coming back, like a slot machine giving you enough small wins to keep you interested.
Furthermore, for every sensible investment rule there are predictable exceptions – survivor bias and tiny sample make us believe that either the evidence is flawed or that we are the exception. We are not.
Having the right financial adviser can play a vital role in helping you tune out the media noise and focus on actions that can improve your investment outcome. The value of financial advice is not just managing the money, but in the softer advisory elements — personal counselling and direction.
* Nick Stewart is an Authorised Financial Adviser and CEO at Stewart Group – a Hawke's Bay-based independent financial advisory firm based in Hastings. Stewart Group works with individuals, families, and businesses in New Zealand who are committed to pursuing financial planning and wellbeing. Our clients understand the value of independent, goal-oriented and objective financial advice that is free of conflicts. If that sounds like you, we would love to hear from you.
* The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961.