The broad remit of our unique Behavioural Finance team is to: help investors make better financial decisions. As a result we spend a lot of our time thinking hard about what constitutes good and bad investment decision making.
Residents of the United States, please read this important information before proceeding
In many domains it is reasonably clear what behaviour is ‘good’, for example: exercise (more), eating (less), gambling (less). In investing, by contrast, it can often appear that there is widespread disagreement on what constitutes ‘good’ behaviour. Should one invest more or less? Invest now, or wait for more certain times?
This is made worse by the fact, discussed in my essay in last month’s Compass , that over any short or medium time horizon, investing outcomes are driven substantially by chance and by events that are out of the control of the decision maker. Any single good decision can turn out badly, and bad decisions can quite accidentally turn out well. We don’t learn much from observing the outcome of individual decisions, but over time many bad decisions will add up to poor results in aggregate. Thus, making good investment decisions requires us to be following a clear and coherent set of principles that amount to a good decision making process.
To help ensure that investment decisions are tipped in favour of good decisions, which over time will maximise your chances of good outcomes, the Behavioural Finance team has gone back to fundamentals to extract what we believe are seven core truths that all investors can subscribe to as articles of faith. Of course these are broad principles, and there may be odd exceptions to the rules, but build your decision process around these, and you can be confident your investing behaviour will be better as a result. Each is followed, in bold, with the generic actions this belief implies.
A Credo for the individual investor
1. Successful investing requires a safe environment – above all it requires sufficient financial liquidity and/or insurance to ensure the investor gets to choose when to sell (is not forced to sell) – Work out what you can afford to invest
2. Getting fully invested as early as possible, at the level of risk appropriate to your risk profile, rather than leaving available capital unutilised delivers the best financial outcomes over time – Put it to work
3. Over time diversification delivers the best returns to all investors for the amount of risk taken regardless of investment amount – Diversify to reduce unnecessary risk
4. The most certain drag on investment performance are costs, fees and taxes. Make sure you know what you’re paying for and why – Reduce costs wherever possible
5. Inaction delivers better financial outcomes than frequent buying/selling – investment returns are about time in the market, not timing the market. Stock picking, currency speculation and market timing are usually costly over time and best left to professionals (if at all) – Do less than you’re inclined to
6. Short term investment outcomes involve considerable luck and it is almost impossible to differentiate luck from skill in the short-term1; in the long term, however, good investment process is likely to pay off – Focus on the long term
7. Long-term investment success requires being sufficiently emotionally comfortable with your portfolio through the investment journey to stick with your plans and follow a good investment process – Reduce your anxiety
Of course, you should bear in mind that, no matter what principles you follow, investment requires taking risk, and risk means investments which can fall in value (and most likely will at various points along the journey). You may get back less than you invest.