When investors consider the financial market impact of rising geopolitical risks the key underlying principle should be the late, great Daniel Kahneman’s maxim that: ‘nothing in life is as important as you think it is, while you are thinking about it’. That is not to suggest that such issues don’t matter, it is simply that they are likely to be less influential on our long run objectives than we think, and even if their impact was to be material our ability to navigate such situations well is highly questionable. Quite simply when we focus on issues that are high profile and salient, we tend to make poor decisions.*

When a geopolitical risk arises our natural tendency is to immediately become foreign policy experts, and also believe that we can confidently link complex and imponderable political situations to financial market outcomes. It is hard to overstate quite how difficult this is.

As is typical for investors, we treat each new event as an isolated incident and develop a convenient amnesia about similar situations in the past, which have either had limited long-term consequences, or where the impact was incredibly difficult to foresee.

It is not enough for something to matter, we must be able to predict it with some degree of confidence.

So, how should investors deal with geopolitical issues and the emergence of other high profile risks?

To keep something of a level-head amidst the noise and tumult, a checklist can be helpful.  We should consider the following:

1) Do I have confidence in predicting the outcome of the current situation?

2) Do I believe I can predict the financial market implications?

3) Are any of these financial market implications likely to be material over my investing horizon?

4) Does my portfolio remain appropriately diversified for a range of different outcomes?

5) Has there been any change to my investing objectives?

In most situations and for most investors, the checklist should result in there being a limited response to emerging geopolitical risks and other types of potential market shocks.

This sounds easy, so why is such an approach difficult to apply?

There is, of course, the incessantly damaging perception that if something is on the front pages, investors should be ‘doing something about it’, but there is an even more pernicious problem. At some point a geopolitical risk will have a major financial market impact, and we cannot face the prospect of having done nothing about it.

The fear of doing nothing whilst something important is unfolding is a real one, and leads many investors (often professionals) to make incredibly poor choices. When considering this conundrum, we need to ask ourselves two questions:

1) Even if we assume that an event will have a meaningful impact on financial markets, how confident are we that we can manage it adroitly? It is a herculean assumption that we will make good choices through a period that is likely to be chaotic, stressful and unpredictable.

2) Will we know in advance which of the many such geopolitical events will be genuinely consequential?  On the very solid assumption that we won’t, this will mean that we must constantly trade around such situations – just in case it is the one that matters.

Although it might be quite difficult to acknowledge, anyone who has lived through financial markets for any period of time will know that Kahneman’s maxim is right. We lurch from one potential major risk to the next, almost always overstating its importance and each time making some ill-judged predictions. Investors need to worry less about geopolitical events, and more about the poor decisions we will make because they are the focus of our attention.  

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* Hopefully, it goes without saying that when I am writing about how much such issues matter it is purely from a financial market perspective. The human costs and implications are often profound and far, far more important than any investing consequences that may transpire.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).