One of the most effective methods for changing our behaviour is to alter the level of friction we face when making a decision. If we want to encourage an action, make it simple. If we want to restrict it, put up obstacles. We use this method intuitively in our everyday life – when we are trying to eat healthily we know it’s best not to have chocolate readily accessible in the fridge – but we tend to understate how the introduction of small amounts of friction can have profound consequences for the choices we make.
Take the case of paracetamol. It is estimated that after the UK introduced limits on the number of tablets contained in a single packet, overdose deaths fell by 43%[i]*. It seems absurd to believe that the implementation of a seemingly slight change could materially influence a decision of unparalleled consequence, but it can. When behaviours are driven by emotion and moments, even minor amounts of friction can exhibit incredible leverage. This is a concept that matters a great deal for investors.
Technological developments have profoundly changed the decision-making experience of both professional and private investors in recent decades. We are awash with information (noise) and stimulus; and have the freedom to transact at any given moment. Technology has made investing seamless. It has removed the friction.
The greater transparency and control investors enjoy is regularly lauded, and it has brought us a wave of benefits; but it also comes with a major shortcoming. The absence of friction allows us to easily take decisions based on how we feel at a given point in time. It makes the most pernicious investing behaviours – performance chasing / market timing / panic selling – easy, and the most important – adopting a long-term approach – more difficult.
Friction in investment has a bad image. We tend to think of it slowing our decision making. Rendering us unable to access opportunities as they arise and suppressing our best instincts. This view is illogical. For most investors, the ability to exploit near-term opportunities or react rapidly to changing market dynamics is a danger not an advantage. Whilst a very select group will attempt such activity for most of us it is a damaging distraction or at best an irrelevance. We tend to perceive friction as a hindrance, but it can quell some of our worst dispositions and promote long-term investing.
It is important to differentiate friction in decision making from outright prohibition. Friction does not prevent us from taking a particular path entirely, it simply slows the process. It introduces time and reflection. Although there may be some investing activities where a complete block might be prudent; in most cases the simple introduction of some level of difficulty or delay is likely to have significant ramifications for our decision making.
For private investors, the notion of friction is often allied to being trapped in poorly performing, expensive funds where extricating yourself from them is seen as too painful, costly or complicated to be worthwhile. This is an undoubted negative friction. Freedom and ease of movement here is essential. Yet a consequence of removing such friction is the ability it gives us to lurch between in-vogue investments and make judgements based on ever-dwindling time horizons.
To counter this, we can introduce our own inhibitors. Part of our long-term investment plan should be specifying limits on how frequently we check our investments (the most effective way to reduce volatility is to review your portfolio less) or put restrictions on the amounts of trades we place. Setting the password for your account to something you are unlikely to remember might have an even greater impact.
It would also be helpful if the investment platforms that we use allowed us to apply our own restrictions when setting-up an account – creating frictions in a cold state that will prevent us making poor decisions in a hot one. For example, there could be a feature where your ability to place trades online is switched off, unless you make a request (which might take 7 days to be approved). Not removing the choice, but introducing a pause.
Even for professional investors, the use of friction can be beneficial. It is typical to pour scorn on ‘committee-led’ decision making and any element of an investment process that seems to undermine the unadulterated views of a fund manager. But they are not immune to short-term thinking or the pressure to react to the prevailing market narrative. Frictions in the process can allow them to be more faithful to their investment objectives, rather than act as an impediment.
Long-term investing has never been more difficult. The freedom, transparency and choice now available to investors which has brought many benefits, also increases the opportunity to make poor decisions. Doing less and enjoying the power of compounding sounds simple but it is far from easy. The more we engage with markets, the greater the temptation is to make choices that feel good now, that we later come to regret.
Taking a long-term approach takes effort and requires assistance. A little bit of friction can go a long way.
* Not all of these will be suicides, and there are several confounding variables that mean that there is significant uncertainty around the 43% figure. There is general agreement, however, that there has been a meaningful impact.