Making better decisions – Understanding Behavioural Finance, Part Six
All of the stuff Greg and I have discussed so far (start the series here) sounds almost like coaching if it’s done right, so I asked Greg Davies if we can learn a better decision-making framework, or are we stuck with what we are by nature? Can we change?
Can we change?
Greg said there are two answers to that. The evidence that we can change who we are is very slight. This is more about self-knowledge: finding out who we are and knowing it, and a personality assessment would give one angle on that. You could also look at your own transaction history honestly, and identify what you do that might be sub-optimal.
The idea is not to change who you are, but to build for yourself a framework that enables you to combat those bits of who you are that might be leading you astray – beeswax and ropes (click here for an explanation).
There are many practical forms of beeswax and ropes, and the most practical use of this is a good investment decision process. Simple things like do you have an asset allocation and do you have a rebalancing policy written down?
A decision-making framework
What this means is that you’ve made a number of decisions ahead of time, in a moment of calm reflection, rather than having to make every decision from scratch in the heat of the moment. Constructing a set of rules for yourself, such as for rebalancing or if the market drops, is something that everyone should do, and it can be as detailed as you want.
Having an investment policy or constitution written down will help us govern our behaviour and act as the guide rules we can use when the Sirens are singing. There are a lot of other things that go along with that.
For example, in Greg’s portfolio, he never takes FX positions or takes currency risks, because he doesn’t know enough about it to be able to beat the FX markets. He removes that temptation and has a list of things he WILL trade in.
Writing down these rules for yourself means that the temptation to dip into things you don’t know anything about doesn’t arise. Another rule should be when do you do things? Greg has a policy that he never makes investment decisions during the week.
When he worked for Barclays, it wasn’t his job to watch the markets day to day, but he saw other people doing so and tried not to be influenced to change his portfolio based on what he saw on their screens. He explained that he didn’t have the time or the information in context to make a good decision – any decisions he made would be rushed and emotionally driven.
Choosing to only look at his investments at the weekend means he has the time to look at his portfolio and his spreadsheet and make decisions. Plus, he has a built-in cooling-off period, because any changes he makes won’t go live until Monday morning, giving him time to reflect.
This is building in the beeswax and practical sets of rules that govern your own emotional tendencies along the way. Different people need different rules, partly because we all have different behavioural inclinations, but partly because we’re trading in different things, or have different horizons.
Your instructions need to be tailored to you, but include things like: what do I not allow myself to do? What is the set of rules I decide ahead of time, so I’m not making every decision from scratch? What information do I look at, and how frequently do I allow myself to look at my portfolio, and when do I allow myself to trade?