Over the course of my conversation with Greg Davies, we looked at the internal and external factors that influence how people choose to invest their money. In this final post, we look at how to look at your own behaviour to help you make better decisions.
Would I buy it now?
Greg explained that: The right question to ask yourself is: “If I didn’t already own it, would I buy it now?”It sounds like a trite soundbite, and it’s a difficult question to ask yourself honestly, but if you can, it will make you a much better investor.
We’ve all heard it before, but how do you genuinely get an answer to the question that’s clean? There are examples of legendary investors, and the following example is possibly apocryphal:
A legendary investor who ran his own investment house in America in the 1960s walked into his firm one day and said: “Today, I want all of you to sell everything. And tomorrow, if you like, you can buy it back again, and I will swallow the transaction costs. We’re all sitting on stuff we own for the wrong reasons, because we’re emotionally attached and we have to break it, because it’s costing us money.”
In a small way, we all face the same thing, because we buy and sell things for the wrong reasons and it’s not necessarily irrational, because it feels comfortable to do so, and we all want to feel like that, but it is costly.
Applying this to portfolio-building
This research is ongoing, as it’s a relatively new field, so I asked Greg if these are things he considers when he’s building his proposition.
He agreed that they were – it’s an integral part of how they view everything, and they try to weave it into the tools they use to profile investors, the tools to build the asset allocation models and the suitability processes (mapping a client to the right answer).
It’s built into the proposition design and how they look at products. Greg said that what’s crucial is that behavioural finance on its own does nothing – it’s a collection of nice ideas. You have to build it into tools, IT systems, sales processes, rules and frameworks. It’s about organisational and proposition design as much as the behavioural stuff.
(Not quite) Everything you need to do
I asked Greg to give some practical advice too, what three things to look out for, three things to do and three things not to do:
Everybody should sit down with a piece of paper and write down their investment philosophy, and what they think constitutes good and bad investment decisions. Think about what you do and don’t invest in, and what your rebalancing policy and risk statement are.
Most people do this on the fly, and so it changes as different circumstances arise. Doing this means you’re much more likely to succumb to emotional biases.
Then, try to take an honest look at your balance sheet and work out what you’ll need in the short to medium term, and then invest the rest.
If you don’t need the money in the short or medium-term, long-term investing is better than having money sitting there doing nothing.
And finally, think about the information you allow yourself to see. If what drives harmful emotional responses and causes anxiety and discomfort is the immediate context, then maybe having a Bloomberg screen constantly pumping numbers at you is not beneficial.
We need to align the information we use to make decisions with our objectives. If your objective is to grow your wealth over five or 10 years and you’re constantly looking at daily returns of things, there’s an instant misalignment between the emotional signals your brain is picking up from the information coming in and what you’re trying to do.
Most of us monitor our portfolios and look at the markets far too much, and we focus on a whole bunch of stuff that seems really important today, but over a five and 10-year horizon really isn’t.
In Daniel Kahneman’s book, he says: “Nothing in life is as important as you think it is, while you’re thinking about it.” The mere fact that we’re thinking about something means that that piece of information is in the front of our minds and is being given too much undue attention.
The world is full of things going wrong, politically and economically, but there is not a single point in history where it wouldn’t have been possible to find a dozen good reasons not to invest, and yet, over the same time, if you’d had chosen not to invest the differences are phenomenal.
Over time, you get rewarded for providing capital for others to put to productive use in the economy. There are times when your portfolio will drop in value, but sitting on the sidelines is costly if you’re an investor.