In Homer’s Odyssey, Ulysses and his crew must navigate their ship past the sirens. The sirens produce a beguiling and irresistible song, which if heard would lead the men to their deaths. To be the first person to hear their song and live, Ulysses applies some behavioural science. He creates a commitment device in the present to protect his future self. He instructs his crew to fill their ears with wax to avoid temptation and has himself tied to the mast to avoid action. If investors want to enjoy the benefits of long-term investing, we must adopt a similar approach.
Stephen Pinker discusses this type of behaviour management in his new book Rationality. He notes that Ulysses surrendered his ability to act and the sailors their option to know. This is puzzling because wilfully relinquishing information and agency seems deeply irrational. Yet if we are aware of the challenges and impulses that await us, it can be the most rational approach to achieving our goals.
As investors we find ourselves in a similar situation to Ulysses. Most of us have long-term objectives best facilitated by doing less, yet the constant noise and narratives of markets are there to lure us into frequent injudicious decisions.
Being a long-term, low action investor is the easiest approach to adopt in theory, but the hardest in practice. How do we make a commitment like Ulysses to protect us from our future investing selves?
Plugging our ears like the sailors means ignoring the chaotic vacillations of markets and the unpredictable path of the economy. Rarely checking our valuations, cutting off our subscriptions to financial news. Avoiding anything that will entice us away from our plan.
Tying ourselves to the mast means making action far more difficult than inaction. Cancelling the brokerage account, losing the password for our portfolios, or adding elements of friction to slow an investment decision-making process.
Of course, we don’t do any of these things. It feels absurd to disregard ‘critical’ information and constrain ourselves from making ‘vital’ investment judgements. We also find it difficult to believe that we will make poor choices in the future – surely, we will behave in a perfectly rational manner no matter the environment?
As with so many things in investment, taking the right behavioural steps to achieve good outcomes can seem irrational and imprudent. Saying ‘I don’t know what markets did yesterday, and I don’t really care’, probably increases the odds that our long-run outcomes will be good, it is just that everybody will think we are incompetent.
Professional investors naturally dislike this type of Ulysses pact. We are paid to engage with markets and act, irrespective of whether that activity is beneficial. We must listen to the siren song and probably erroneously believe we can avoid the rocks whilst enjoying the melody.
Commitment devices do not have to be entirely restrictive, however. They can be designed so that our future self is more likely to exploit opportunities that arise. We might commit to acting only when certain extreme valuation levels are reached. This approach is obviously imperfect compared to an avoidance pact because we will still have to implement the decision when the time arrives (and will no doubt create excuses as to why it is no longer a good idea). Setting a high threshold for action, however, at least protects from the worst ravages of noise and overtrading.
A critical part of managing our behaviour is understanding the challenges we will face and planning in advance how we will mitigate them. Good investment is primarily about making sensible decisions at the start and avoiding bad decisions on the journey. The problem is that the compulsion to veer off course is likely to be overwhelming.
Most of us want to be long-term investors, but unless we make the right behavioural commitments at the outset the siren song of financial markets will make that an impossible aspiration.