Despite the paramount importance of the findings of behavioural science to our investment decision making, there is limited evidence of its lessons and principles being applied. Given the long-term benefits from engagement with this area, why has there been such a reticence to embrace behavioural concepts? There are four factors, which I consider to be the major impediments:
- Individual Acceptance: The investment community has certainly not ignored behavioural science, but there is a tendency to consider how it affects other people. Acknowledging personal behavioural vulnerabilities is not easy; particularly for professional investors operating in an industry where accepting mistakes and limitations can have a deleterious impact on career prospects. However, individual ownership is crucial if behavioural issues are to be tackled.
- Amorphous Ideas: The range of biases highlighted and heuristics identified in behavioural research is vast; furthermore, they frequently overlap, are sometimes contradictory, can suffer from replication issues and are often not directly related to the field of investment. Given these factors, the struggle to develop a coherent means of addressing the topic is unsurprising.
- Challenging Application: Developing solutions that serve to mitigate the impact of behavioural weaknesses is difficult; they often face criticism for being too simplistic (‘surely re-ordering the presentation of performance data won’t impact our decision making’ ) or are contrary to conventional wisdom (‘I need to be on top of my portfolio, so checking it less is not a feasible option’). More broadly, there is limited empirical evidence on successful ‘de-biasing’ strategies that are directly applicable to investment decision making.
- Investment Process Afterthought: Through a combination of the aforementioned factors, behavioural concepts are often an afterthought in an investment process, serving at best as an adjunct to the ‘real’ investment decision making and, at worst, a pure marketing ploy designed to capture some kudos from the current interest in the topic, but lacking in any substantive value.
These issues are by no means insurmountable, but action is required to effectively incorporate behavioural science in a meaningful and consistent fashion. As simplicity is at the heart of most successful behavioural interventions; an ideal starting point is to develop a checklist encompassing the most significant and influential behavioural hurdles. Although a seemingly minor advance, such a step could have a material impact on investment decision making.
As detailed in the popular and engaging ‘The Checklist Manifesto’ (Gawande, 2009); concise checklists are an incredibly effective means of encouraging behavioural consistency, whilst limiting mistakes and omissions. Furthermore, if correctly structured, they can easily be integrated within existing processes and rapidly applied. Of course, a behavioural checklist for investors cannot be as specific or definite as those that might apply in surgery or aviation; however, they can serve to ensure that the consideration of behavioural issues becomes an integral part of the decision process.
Although it may seem superfluous, making a checklist memorable is also a vital means of ingraining its core ideas. Behavioural science is particularly fond of acronyms; notably, the MINDSPACE and EAST structures employed by the UK Behavioural Insights Team when designing policy (EAST, for example denotes: Easy, Timely, Attractive and Social). More prominent, on a global scale, is Thaler and Sunstein’s highly influential NUDGES framework.
Given that the purpose of this behavioural checklist is to better reflect on our own and others’ investment decision making, I propose the use of MIRRORS, where each letter pertains to a prominent behavioural factor that exerts a material influence on investors:
|M||Myopia||We are overly influenced by short-term considerations|
|I||Integration||We seek to conform to group behaviour and prevailing norms|
|R||Recency||We overweight the importance of recent events|
|R||Risk Perception||We are poor at assessing risks and gauging probabilities|
|O||Outcomes||We focus on outcomes when evaluating the quality of a process|
|R||Reference Points||We make judgements using, often erroneous, reference points|
|S||Stories||We are frequently beguiled by compelling narratives|
Whilst there is depth and complexity underpinning the behavioural issues included in the checklist, which I will endeavour to explore in future posts, the fundamental problems and potential implications of each should be readily apparent.
The checklist is not designed to be exhaustive, thus there will inevitably be pertinent issues not adequately captured; however, it incorporates what I perceive to be the major behavioural impediments encountered, and those which forge a significant ‘behaviour gap’ between underlying asset performance and the returns realised by investors. Moreover, employing a concentrated list makes it simple to bring these crucial considerations from the periphery to the core of investment decision making
Creating a checklist is, of course, no panacea and one cannot hope to ameliorate the impact of ingrained biases and predilections, simply by ticking boxes. However, the starting point for improvement in our investment choices and judgements is an awareness and acceptance of our behavioural flaws. Employing a checklist is an acknowledgement of susceptibility and an expression of willingness to engage with the issues in a consistent and rigorous fashion.
In my next post, I will explore in greater detail how such a checklist might be utilised as part of an investment decision making process both to stimulate debate and to develop interventions. However, even without a precise application in mind, simply beginning to think about and discuss the areas covered in the checklist when making decisions should prove a major benefit to investors.
Dolan, P., Hallsworth, M., Halpern, D., King, D., & Vlaev, I. (2010). MINDSPACE: influencing behaviour for public policy.
Gawande, A. (2010). The checklist manifesto : How to get things right. London: Profile Books.
Insights, B. (2014). EAST: Four Simple Ways to Apply Behavioural Insights. London: Behavioural Insights.
Sunstein, C., & Thaler, R. (2008). Nudge. The politics of libertarian paternalism. New Haven.