It is easy to think of investing as a technical endeavour, where we can develop specialist knowledge and insights to improve our results. We expend a huge amount of time and energy on enhancing models or refining processes to gain some edge or advantage. It is difficult to argue against this drive for progress. Yet, in investment, what feels right can often lead to worse outcomes. The desire for more information, more precision and more complexity almost inevitably impairs the quality of our decision making.
Despite its rise to prominence in recent years, investors are still not thinking about behaviour nearly enough.
The arms race to improve technical sophistication is understandable, but a major failure in prioritisation. Do we really believe that our analysis is going to be better than the next person? Is it worth allocating inordinate resource to the slim chance that it might be? Are our research and analytics going to be superior to the house with 100x the capabilities that I / we have?
There is nothing wrong with enhancing our technical proficiency, but it should be subordinate to considering our behaviour. The potential to improve our results by understanding and managing our behaviour outstrips any other changes we could make that might enhance our investment fortunes.
The first question any investor should ask is – how can I create an environment that minimises the behavioural challenges I will face?
So, why don’t we do it? In part, it is because we still don’t believe it. We can pay lip service to behaviour, but at heart we still see ourselves as rational decision makers.
Most importantly, making behaviour the critical part of an investment approach doesn’t feel or look right. Creating strong behavioural frameworks is often about doing less. Less activity, less information and fewer decision points. Good luck trying to pitch that.
To be successful long-term investors, particularly if we have short-term accountability, is staggeringly difficult. The very minimum we should be doing is acknowledging that the potential to make poor short-term decisions based on noise, emotion and incentives is exceedingly high.
Our default expectation should be that over the long-run we will make a lot of bad investment decisions driven by our behavioural limitations.
We should be trying to fix that first, rather than worrying about extracting some uncertain analytical edge.
The question that is never asked
The problem with treating behaviour like a distracting but ultimately meaningless sideshow is not only evident in the lack of priority attached to it, but how rarely it seems to be considered across the industry. All the way from asset managers to technology providers and regulators.
The obvious example is about the access all investors now have to their portfolios / investment accounts. An optically wonderful development but what are the behavioural consequences? (They seem obvious to me).
Whenever anyone is making a change to an investment process the first question that should be asked is:
“How will this impact behaviour?”
I am not sure it is ever asked.
Every change we make to our approach to investment will alter our behaviour. Even slight, seemingly inconsequential adjustments can have a profound influence on our judgements.
So often alterations are made which have good intentions but spell behavioural disaster. It is difficult to think of many developments in the investment industry in recent years that are not likely to make us more short-term and trade more frequently.
But if behaviour is so important, why don’t we care about it enough?
1) Many things that are likely to aid our behaviour appear regressive and unsophisticated (less interaction with markets / fewer decisions). Constraining choice, reducing information and adding friction rarely seems like a winning ticket.
2) As we struggle to see behavioural weakness in ourselves, we find it difficult to understand how it will likely impact other investors.
3) Many behavioural issues seem so minor that they are easy to disregard. We should never underestimate how small changes will have dramatic consequences for choices and outcomes.
4) The requirements to be a good behavioural investor run counter to the structure of the industry and its incentives. The management of career and business risk are far more powerful than many realise. Short-term incentives always trump aspirations of good long-term behaviour.
5) The benefits of good behaviour are not always easy to see. There is no obvious counter-factual and they accrue over the long-term. We much prefer quick wins or approaches that feel like quick wins (but create long-term losses).
6) Good behaviour that gets the odds on our side can feel very painful in the short-term and is easy to abandon. It is not comfortable spending time doing less, when everyone else is doing more.
Every development to an investment process, platform or piece of regulation should be viewed through a behavioural lens. Ideally, each change should be designed to improve investor behaviour, as nothing will provide a greater net benefit. When changes are implemented that have the potential for negative behavioural consequences then specific steps should be taken to ameliorate these. This is the least we can do.
There is plenty of talk about behaviour, but unfortunately not much action.