The Evidence-Based Investor

Successful investing begins with knowing yourself

Posted by Robin Powell on December 15, 2017

“Rip Van Winkle would be the ideal stock market investor,” Richard Thaler, the Nobel Prize-winning behavioural economist, once pointed out. “Rip could invest in the market before his nap and when he woke up 20 years later, he’d be happy. He would have been asleep through all the ups and downs in between.”

The problem, of course, is that unlike Mr Van Winkle, we can’t just go to sleep and wake up when it’s time to retire. We live life in real-time and, let’s face it, the world can be a scary place.

This is not to have a go at journalists — I am, after all, one of them myself — but there is tendency in the financial media, and the news media more generally, to accentuate the negative. If we really want to, we can see the value of our investments going up and down minute by minute, and there’s always some self-appointed expert telling us that now is the time to get in or out of the market.

 

 

Of course, sooner or later, one of these experts will be right. Even a broken clock is right twice a day. And you can bet that whoever calls the next crash at  just the right time will be feted as as the next stock market genius. The problem is, that the vast majority of market forecasts are completely wrong, and acting on them will leave you with a smaller pension pot.

Morgan Housel wrote an excellent post the other day, entitled How to Read Financial News. I would urge every investor to read it. I’m not one of those who say that investors should ignore the financial news altogether. In the real world you can’t. But you should remember that most of it is noise. Stories that make you worry today will be a distant memory in one, five or ten years’ time.

Morgan also features in Part 5 of Investing: The Evidence, Regis Media’s new landmark documentary for the UK-based financial planning firm RockWealth.

This particular video focuses on behaviour, and explains how, ultimately, whether or not you succeed as an investor is essentially up to you. Yes, cutting the cost of investing by using low-cost, passively managed funds is hugely important, but an even bigger factor in determining your eventual returns will be is just how disciplined you are.

Morgan puts it like this:

“You have to know your own temperament, your own appetite for risk, your own ability to over-react in highly emotional situations. Every investor needs to know that about themselves, and then lay on a framework for investing that fits that personality. If you are a highly emotional person who is susceptible to the big ups and downs of the markets, having a pretty conservative investing style is the right way to go for you.

“I think a lot of investors try to manage around optimising down to the basis point, what’s the best portfolio for me to own, and then in 2009 the market falls 50% and they’re out, and they’re panicked. And at that point, all the optimisation that you did before doesn’t matter any more. So if you can nail down the behavioural aspect of investing, all of the optimisation that we layer on top of that matters less and less. It’s not that it doesn’t matter; it’s just of less importance than other aspects of investing.”

I couldn’t agree more. You can know all there is to know about evidence-based investing. You might be a world authority on Modern Portfolio Theory, or quote Paul Samuelson in your sleep. But if you don’t know yourself, it won’t get you very far as an investor.

 

Ultimately, whether or not you succeed as an investor is down to you and how disciplined or otherwise you are


Have you seen the first four videos in this series? If not, you can catch up here:

Part 1: Active investing

Part 2: Passive investing

Part 3: Factor investing

Part 4: Risk

 

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Share this film and change investing for good

 

ROBIN POWELL is the founder and editor of The Evidence-Based Investor. A freelance journalist, he runs Regis Media, a specialist content marketing consultancy for financial advice firms around the world. You can follow him on Twitter and on LinkedIn.


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Regis Media, which produces The Evidence-Based Investor, has a wide range of videos and articles that can be branded for financial advice firms that share our investment philosophy. You’ll find details and prices on our website and explanatory videos on our YouTube channel.

 

Video transcript:

So far we’ve looked at three different types of investing. First, the evidence shows, you should avoid using actively managed funds altogether. So, what should you use? Well, either, passively managed funds, or funds that are designed to capture the returns of specific risk factors — or indeed a combination of the two.

We’ve also seen the importance of matching your portfolio to your capacity for risk. Ultimately, though, whether or not you succeed as an investor is essentially up to you. 

Tim Richards, an expert in behavioural finance, says: “The way that people behave, particularly in the presence of money, isn’t what anybody would expect. It’s irrational, because in essence people will behave in ways that mean they will lose money, and you can predict that they’ll lose money because of the way they are actually behaving. So there’s this gap between what you would expect people to do rationally and what they actually do when they’re put in the situation of finance and money and investment and risk and uncertainty; there’s this hole.

“Some studies have shown 3 to 4% a year is being dropped by investors, purely because of making poor buying and selling decisions. Now that’s just one bias — that’s just one type of issue that they’re facing. So if people are consistently making mistakes in terms of when they buy and when they sell stocks, over a lifetime that’s thousands, hundreds of thousands, millions of pounds. And if you scale that up across the industry, it’s billions of pounds a year.”

It’s because the returns you end up with depend so heavily on your behaviour that self-awareness is so important. Understanding your own personality, what your goals are and which biases you’re particularly prone to, will help you to manage that behaviour in the years to come.

Investment blogger Morgan Housel says: “You have to know your own temperament, your own appetite for risk, your own ability to over-react in highly emotional situations. Every investor needs to know that about themselves, and then lay on a framework for investing that fits that personality. If you are a highly emotional person who is susceptible to the big ups and downs of the markets, having a pretty conservative investing style is the right way to go for you.

“I think a lot of investors try to manage around optimising down to the basis point, what’s the best portfolio for me to own, and then in 2009 the market falls 50% and they’re out, and they’re panicked. And at that point, all the optimisation that you did before doesn’t matter any more. So if you can nail down the behavioural aspect of investing, all of the optimisation that we layer on top of that matters less and less. It’s not that it doesn’t matter; it’s just of less importance than other aspects of investing.”

A constant temptation investors face is to try to time the market, but it’s almost impossible to do successfully.

Between the two world wars, the bursar of King’s College, Cambridge, and the man responsible for the college’s investment strategy, was the famous economist, John Maynard Keynes. He tried to get into the market when prices were about to rise, and out again before they fell, but even he missed the most infamous market crash of all.

David Chambers from Cambridge Judge Business School says: “Keynes ran portfolios both for himself and his college, amongst other investors, for about a quarter of a century, and one of the key things that he learned about investing was the great difficulty, or indeed the futility, of market timing. By market timing what we mean is trying to pick the points where you should be in or out of the equity market, as opposed to being in bonds or cash, for example, because those were the three major asset classes that were available to him, in addition to property, in the ‘20s and the ‘30s.

“He pored over economic and industrial statistics, and indeed he founded the premier economic statistical service of its day. Despite all those advantages, as well as being a great economist, he found it very difficult to time when to get in and when to get out of the equity market. And probably the prime example of that is that in October 1929, when the London stock market crashed, along with New York, he was still very heavily into equities.”

You’ll often see experts speculating in the media about the likely impact on the markets of major political events like referendums or general elections. But, almost invariably, at times such as these, it’s better to leave your portfolio exactly as it is.

Peter Westaway from Vanguard Asset Management says: “Political events are very difficult to predict in advance. With a couple in particular — Brexit and Trump — a few months before that they were completely off the radar. But what’s interesting is that, even if you had been able to predict some of these events in advance, being able to predict how the markets were going to respond to those events once they happened was also very difficult.

“So we saw, for example, in the UK, that markets didn’t collapse — the stock market didn’t collapse after the Brexit vote. The currency did, actually, but stock markets didn’t. In the US we actually saw the opposite. The stock market started to surge on the expectation of some expansionary policies, and again, most investors, even so-called informed investors, wouldn’t have been positioned for that.”

David Pitt-Watson from London Business School says: “If I want a real stream of income, that’s diversified, for the long term, equities are quite a good thing to be invested in. You take a risk coming out, and you take a risk going in, that you know better than anybody else, and throwing that dice will cost me several per cent, of which I’ll only know a very small part. All the rest will be in transaction costs. So again, start with fundamentals, stick with fundamentals, and you’re likely to do an awful lot better than people who are tying to switch in and out all of the time.”

In fact, human beings are hardwired to make poor investment decisions. When markets soar, the reflexive nucleus accumbens fires up at the back of the brain’s frontal lobe, and we instinctively want to buy.

But when markets tumble, our brain’s amygdala floods our bloodstream with corticosterone. Fear kicks in and we’re overwhelmed by the urge to sell. Indeed, it’s during a crash or market correction that investors tend to make their  biggest mistakes.

Investment author Lars Kroijer says: “So how should you react? A lot of that is about looking inward. What is your risk tolerance? Has anything changed in terms of your knowledge about the markets and your ability to outperform the markets? The overwhelming likelihood is the answer is No. If it’s now March 2009 and you’ve lost half your money, you still can’t outperform the market, you still can’t know what’s going to happen 12 months hence. But that doesn’t mean that the decline hasn’t altered your circumstances. It might paradoxically be that, as the result of a great loss, you have a lesser tolerance of risk. That’s a personal thing and you should treat it as that.”

Stock markets have always been subject to periods of extreme volatility, and always will be. We can’t be sure how we’re going to react until we find ourselves in just that sort of situation. The important thing is to be prepared. Understand how markets work; understand your plan; and, most of all, understand yourself. The greatest threat to your success as an investor is you.

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Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector. Regis Media.

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