An eternity ago (around four months), financial market commentary was dominated by confident predictions of the investment implications of Trump’s second term and countless descriptions of the inevitable performance advantage of US equities. Since this point, we have seen markets behave in an almost entirely contrary fashion to most of these forecasts (I don’t remember hearing many people call for the outperformance of Chinese and European equities). The problem is no matter how many times we get taught the same lesson about the futility and danger of such behaviour, we just cannot help ourselves.

One of the reasons that we perpetually repeat the same mistakes is that investors are incredibly adept at moving on from the things that we were thinking, saying and doing in the past (even if it is the very recent past) as soon as something else happens. While this does help us avoid coming to terms with the painful realisation of how little we know, it doesn’t help us make better future decisions.

About those ‘Trump trades’

Back in November I wrote that trying to forecast the market impact of the US election was a ‘wretched idea’. This was not due to the sheer unpredictability of Donald Trump, but because the global economy and financial markets are unfathomably complex systems and trying to anticipate them is impossible with any degree of confidence or accuracy.

The very notion that there is a straightforward relationship between a binary event (such as an election) and a financial market reaction (a strengthening dollar) is absurd. There may be self-perpetuating short-term reactions to such occurrences – investors trade based on what they think other investors will do – but, after this, things get incredibly messy, very quickly. Complex systems – like economies – are defined by being comprised of many component parts that interact with eachother, often in entirely unforeseeable and chaotic ways.

The issue is not that some of the higher profile ‘Trump trades’ look wrong at the moment – nobody knows how markets will progress from here – but that this type of investment thinking is totally at odds with reality.

European equities – dead or alive?

It may be hard to believe now, but the general sentiment around European equities in 2024 was almost uniformly negative. The sluggish European economy was blighted by bureaucracy and regulation, and their financial markets would never allow for the growth of hugely profitable technology-orientated firms like the Magnificent 7 in the US. Why would anybody invest in a laggard like Europe?

Well, it only takes two months of outperformance for those narratives to change. Now investors are hastily checking that they have enough exposure to a reawakening European economy. So much for the US being the exceptional market.

The old and new arguments are both ridiculously overconfident. The idea of US exceptionalism became as exaggerated as the dramatic transformation of sentiment towards Europe.  

Investor feelings and behaviour are overwhelming dominated by short-term performance and the stories we create to justify it; most strongly held investing beliefs can withstand about a quarter of underperformance. This is because we are obsessed with what is happening right now and can’t seem to shake the belief that whatever it is will continue. 

The truth is nobody knows whether the recent upturn in fortunes from European equities represents a new trend; we could just as easily revert to the performance patterns that have defined the past decade and more.

The fact that we cannot see the future means that we should always be diversified, and that means holding assets that even we might have written off ourselves.

Defensive investing

One of the more remarkable features of recent market moves is the performance of the European defence stocks. The current fervour for this area is in stark contract to five years prior when investors seemed incredibly keen to add such names to ESG exclusions lists and remove them from portfolios.

I have no wish to opine on the rights and wrongs of removing defence companies from a portfolio, but the dramatic shift in sentiment is a useful reminder not only that the world changes, but how we feel about the world also develops through time. We are all prone to believe that the things we think and feel presently are unshakeable. This is not true, not only will the environment around us evolve, but our perspectives and opinions are likely to alter with it.

What we staunchly believe now, may be very different in five years’ time for a plethora of reasons. We should always ensure our decision making is not so dogmatic that it fails to reflect this possibility.

The other – perhaps unpalatable – point is that our investment preferences are (like everything else) impacted by returns. Exclusions that are driven by genuine values are not always immune performance pressure.

We still can’t predict catalysts

Amongst strong competition, ‘catalyst’ is one of my least favourite investing words. People spend an inordinate amount of time talking and thinking about catalysts, but in the vast majority of cases all they are doing is trying to predict changes in market sentiment. Which, as you may have guessed by now, I do not believe we can do.

Imagine that last year you had a constructive long-term view on European equities because you felt that they were attractively valued – someone would have inevitably said: “That’s great, but what is the catalyst?”

Would you have said:

“Well, I think Trump will be elected as US President and his actions will shake the global world order, this will leave Europeans doubting the reliability of their most powerful ally, which will lead them to loosen fiscal constraints and improve nominal GDP prospects, and this will provide a major boost to earnings and sentiment.”

This would have been incredible foresight and if anyone did predict this, I missed it when reading through the 2025 outlooks.   

Investors see catalysts everywhere when they look at past performance, but most of the time these are just stories told to explain outcomes. Most developments in financial markets do not have individual catalysts but come about due to a confluence of factors. Even on the occasions where there is an obvious singular catalyst – it is typically only observable after the fact.

Performance always comes first, explanations second.

Didn’t know then, and don’t know now

There have been some surprising developments already this year, which might mean that investors are reining in their attempts to forecast the future. Unfortunately not. One of the most puzzling but inevitable investor reactions to being blindsided by market developments is to immediately start trying to predict what comes next.

We were wrong then, but we will be right now.

The quicker we accept all that we cannot know or foresee, the quicker we can make sensible investment decisions that reflect that frustrating but inevitable reality.

—

For investors it seems that being consistently wrong is far more comfortable than being uncertain. So, despite the early months of 2025 giving us yet another valuable lesson in what we shouldn’t be doing, we will no doubt carry on regardless.

–

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).  

At the 1998 shareholder meeting for Berkshire Hathaway, Warren Buffett said: “We try to think about two things: things that are important and things that are knowable.” Although at first glance this comment can seem quite innocuous, it is an essential idea to understand if we are to successfully navigate the uncertainty and noise of financial markets. Investors are generally quite poor at defining what matters to them and why; and this is a problem which causes all sorts of decision-making challenges. There is, however, a quick way to get better at this – a crystal ball test. 

Before describing the test, let’s reflect on what Buffett is getting at here. He is saying that for his investment approach there are only a select number of elements that will influence results over time and an even smaller number of this group that are knowable (or predictable) to any reasonable extent. That is where his focus is.

Of course, nothing is perfectly knowable, but there are some things that we can have a sufficient level of confidence in, and many others that are, if not random, pretty close to it. The are far more things in the latter group than the former and distinguishing between them is vital.

Before worrying about whether something is knowable, we need to define which factors we believe are important to the success of our investment. How do we do that? Let’s turn to the crystal ball.

We can ask ourselves, and other investors, this question:

“If you had a crystal ball and could see one piece of information in the future that would materially influence this investment view, what would it be?”

We can apply this question to any type of investment – whether it be about an individual stock, or a major asset allocation shift. It should quickly elicit what we think the most important factors are, and then we can judge if there is any chance of us predicting it without the aid of a crystal ball.

Let’s take an example. If I had to take a view on the performance of ten year treasuries over the next five years, what would I want to foresee using the crystal ball? It would be US inflation in five years’ time.

This tells you that – for me – inflation is the most important variable in determining the returns of ten year treasuries over the next five years. Unfortunately, I have no idea what the rate of inflation will be, which obviously will impact how much conviction I would ever take in a view on US treasuries.

We can also invert the crystal ball question to get to a similar answer by asking:

“If you knew the outcome of X in advance, how would it impact your decision?”

If I knew the rate of inflation in the US would be 6% in five years’ time, it would almost certainly influence my view on US treasuries.

This type of question can help us cut short situations where people are debating some financial market issue that is not only unknowable but, even if we could predict it, we wouldn’t know what to do about it. (Elections are the gift that keeps on giving in this regard).

Using Buffett’s important and knowable framing, we can think about the usefulness of a crystal ball in three different ways:

– Something is both important and knowable: A crystal ball might help a little, but not much because we are reasonably confident in the variable anyway. (Think here of things like long-run earnings growth or starting valuations).

–  Something is important and not knowable: A crystal ball is absolutely vital because something matters but we cannot anticipate it.

– Something is not important and not knowable: We can use the crystal ball as a paperweight because even seeing the future is of no use to us.  

Unfortunately, investors are prone to spending far too much time in the latter two groups. Either making decisions that are heavily influenced by variables that are inherently unknowable, or wasting time on things that wouldn’t be useful even if they were knowable (which they aren’t).  

The crystal ball test can be an exceptionally useful means of better understanding what type of investor we and others are. It is particularly effective in gauging what an investors’ true time horizon is (the factors that matter change with our horizon) and what variables are foremost in our thinking.

It is also a great sense check to stop ourselves spending an inordinate amount of time on financial market issues just because they are at the front of everyone’s mind, not because they are consequential.

How best can we incorporate Buffett’s thinking on focusing on what’s important and what is knowable into practice? I think there are seven key aspects. We should:

1) Be clear about the variables that are important to the success of our investment decision. 

2) Understand whether these are sufficiently knowable / predictable.

3) Focus on elements that are both important and knowable.

4) Be aware of things that are important to our view but inherently unknowable.

5) Avoid high conviction investment views that are heavily reliant on unknowable variables.

6) Use diversification to protect against important but unknowable factors.

7) Stop worrying about things that are neither important nor knowable.  

Investors are best served by adopting an approach where the most important determinants of success are also at least somewhat knowable. If we need a crystal ball for good outcomes, I don’t like our chances.

—

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).

Humans hate uncertainty. The more uncertain we feel the more we take actions to restore a sense of control. For investors one inevitable response to increasing uncertainty is to make more predictions. If we can see the future, then we don’t need to worry about it. This creates the paradoxical situation where the harder predictions are to make, the more we want to make them. 

In his fantastic book ‘Alchemy‘, Rory Sutherland gives an example of our aversion to uncertainty:

We are taking a flight to Frankfurt, which departure board would we prefer to see?

Option 1: BA 786 – Frankfurt- Delayed 

Option 2: BA 786 – Frankfurt – Delayed 70 minutes

Although the delay in Option 2 is frustrating, it is far superior to Option 1 because it reduces the nagging discomfort of uncertainty. It gives us a little more confidence that the plane will actually take off and some idea of how much time we have. In Option 1, we know next to nothing and that causes considerable psychological pain.

In a similar fashion, Sutherland gives the example of the maps provided to show us where our Uber driver is. They don’t make the car get to us any faster, but they negate the uncertainty around when it will arrive. Investor predictions are a form of map making. They give us a guide to the future and, in theory, help to alleviate uncertainty. The problem is that financial markets are so chaotic and complex that the maps investors make are not much use.

It is possible to argue that hopelessly predicting our way through an uncertain environment is a good thing – if it makes us feel less anxious, maybe it is okay? I don’t think this is true. Investors holding a false sense of confidence about how the world will play out is likely to lead to worse decisions, not better. 

Successful investing is about making choices that acknowledge uncertainty, not acting as if it can be avoided. 

Our dislike of uncertainty makes selling certainty incredibly lucrative. We see it everywhere in the investment industry. Whether it is investment funds that claim they can navigate all environments with equanimity, or soothsayers selling investment forecasts. They prey on the pain of uncertainty by acting as if they are somehow prescient. (They are not).

Despite the discomfort that uncertainty causes investors, we do have a tendency to make things worse for ourselves. By engaging with markets too frequently we exacerbate our feelings of helplessness. We seem to believe that interacting with markets more will give us that elusive sense of control. Unfortunately it has the opposite effect. The more we immerse ourselves, the more likely we are to be captured by its ingrained unpredictability and amplify the behavioural risks we face.

There is no way to remove the uncertainty inherent in financial markets but we can adapt our behaviour to better deal with it.

The most important step is to value principles far more than predictions. A focus on sound investment principles such as diversification, long horizons and the power of compounding rather than inaccurate forecasts about an unpredictable future is essential. 

Robust investment principles do not remove uncertainty (particularly over the short-term), but make us more resilient to it.

We also need to care about the right things. I have no idea what inflation will be in two years’ time nor what the Federal funds rate will be (nobody does), but I am reasonably confident that over the long-run economies will grow and that will flow through into corporate profits and stock market performance.

Nothing is certain but some things are more certain than others.

We all loathe uncertainty, but it is an inescapable feature of investing that we have to deal with. Our attempts to minimize it can lead to greater anxiety and poor judgements. Rather than seek illusory comfort from unreliable predictions or constantly redrawing useless maps, we are far better off accepting uncertainty and ensuring that the investment principles we hold are sufficiently robust that we have a chance of withstanding it.

That is the only way of being a little more certain of better long-run outcomes.

—

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).

One of the key challenges faced by investors aiming to generate long-term returns with a diversified portfolio is ‘line-item thinking’. This is where we obsess over the success or failure of individual positions, often losing sight of our true investment goals and the principles of sound diversification. A good investment decision is not the same as a good portfolio decision. 

Portfolio objectives are often framed in terms of beating a benchmark or ‘optimising’ for a given level of risk. Neither of these feels quite right. A benchmark-centric approach implicitly assumes that the benchmark is the correct base mix of assets for our requirements; while optimisations that are striving for ‘return maximisation’ within certain parameters suffer from inputting forecasts that we know will be wrong into a system very sensitive to those incorrect forecasts.

Rather I think for most individuals the objectives of our portfolios should be something along the lines of:

To maximise the probability of delivering good outcomes and minimise the probability of very bad outcomes.

It follows that any decision we make regarding our portfolio should be consistent with achieving those aims; and this is where the issue of line-item thinking arises.

What is line-item thinking? It is characterised by these types of behaviours:

– Thinking about the attractiveness of an investment on a standalone basis, or relative to one other asset. (I expect US equities to outperform emerging market equities, so I am overweight).

– Thinking about how an investment will perform in one future scenario. (I don’t think there will be a recession this year, so I prefer high yield to high grade credit).

– Thinking in terms of profit and loss, and whether an individual position ‘added value’. (This position detracted value and therefore was a mistake).

Although line-item thinking can seem reasonable in isolation, it is often antithetical to good portfolio decision making. None of the three examples above really help me achieve my portfolio objectives as described; they may even hinder it.

Positive portfolio decisions can often seem like bad line-item decisions.

Portfolio Neglect 

The principal reason we build portfolios that combine different assets, funds and securities is diversification. The future is unknowable and therefore we want to create a combination of holdings that is resilient to that uncertainty. If we could predict the future, then we would only hold one security in our portfolio.

This brings us to the central behavioural challenge of diversification. Proof of it being effective comes in the form of assets and positions performing poorly (certainly relative to other things that we hold), but we have little appetite for owning stragglers. 

Good diversification is about making choices that we expect to work in a world that we don’t expect to happen.

Line-item thinking exacerbates this problem because instead of considering the role each holding plays in meeting the objectives of our diversified portfolio, we think about them independently  – did this asset, fund or view outperform or not? It works in binary, deterministic terms.

It is always about outcome bias

Outcome bias (our propensity to judge the quality of a decision by results alone) is one of our most pernicious and powerful behavioural failings. We cannot resist assessing portfolio performance after the fact and judging how the different components have fared. The underperformers and idlers are classed as poor decisions that cause us anxiety, while the outperformers are evidence of sound judgement.

This perspective makes sense through a line-item lens, but it is entirely inconsistent with making sensible portfolio decisions. We can quite easily make choices where an individual position performs well, but fails both criteria of increasing the probability of good outcomes and minimising the probability of very bad outcomes (particularly when only observing short-run returns).

The central issue is that good portfolio decisions are designed to make us robust to a range of unpredictable future results; if we do this, by definition, a decent chunk of our portfolio will look ‘wrong’ with the benefit of hindsight.

Our portfolio performance assessments come once a single market or economic path has been charted.  Diversification always feels like a cost because nothing seems uncertain through the rear view mirror. Line-item thinking comes to the fore here – we look at each position, assess its performance and probably focus on the ones that have struggled.

This seems reasonable but is a terrible idea from a portfolio perspective. But what is the alternative? There are three critical portfolio-thinking questions to ask about the performance of individual positions:

– Was the decision reasonable at the time it was made given what we knew?

– Has the asset behaved in a manner that was broadly consistent with expectations / or its role in the portfolio?

– Did the decision meet the criteria of increasing the probability of good outcomes and minimising the probability of very bad outcomes?

Of course, asking people to think less about outperformance / underperformance of any given position is an entirely futile exercise. What’s measured is what matters! But the more that we think in such a manner, the less likely we are to make decisions that are consistent with meeting our overall portfolio objectives.

Line-item thinking is everywhere. Not a year goes by when the last rites aren’t read for a particular type of asset that hasn’t performed well. Bonds, value investing, liquid alternatives, non-US equities…have all come into the crosshairs in recent times.

These types of claims make sense from a line-item perspective, few of them do from a portfolio one. 

Line-Item Duty

Given that it is portfolio outcomes that matter to us, not the ‘success’ or ‘failure’ of any specific position, why is line-item thinking so prevalent? One undeniable reason is simply availability – we see the line items, so we care about each of them – but there is a deep irony here. We like to check that we are diversified by looking at all the underlying holdings in our portfolio (we don’t want to see just a single line in our valuation even if there is plenty of diversification underneath that); but when we can view each of the underlying positions, it inevitably makes us want to rid ourselves of the poor performers.

Our desire to find proof of diversification leads to behaviour where we become less diversified.

Line-item thinking is also easy. Easy to prove and easy to measure. Positions either work or they don’t, and we were either right about how things panned out or we were wrong. Even attempting to explain why we might be happy that certain positions looked to have performed disappointingly, or why a decision that looks like a poor one actually made a portfolio more likely to meet long-run objectives is likely to be met with scorn.

The consequences of line-item thinking

There are several significant and deleterious consequences of line-item thinking:

Increasing portfolio concentration: Removing the laggards and increasing exposure to the winners is an inevitable consequence of line-item thinking – we don’t want to hold positions that are underperforming, so we reduce diversification and concentrate on the things that we got ‘right’. We create portfolios for the known past, not an uncertain future.

Less portfolio resilience: Line-item thinking means that we focus on whether a position is likely to outperform / underperform, rather than consider the role it might play in making a portfolio more robust to certain outcomes. A position that performs very strongly in a future that has a 30% probability of occurring can be incredibly valuable, even if on 70% of occasions it will look like a failure (on a line-item basis). 

Too much risk: Line-item thinking will perpetually bias us towards higher return / higher risk assets. If we have the choice between two assets – we are always likely to favour that with a higher return potential even if it carries more risk and is less diversifying, because from a line-item perspective it is more likely to outperform.   

Too much trading: Over-trading is an inevitable consequence of line-item thinking as we continually trade in and out of assets as they go through their performance cycles. Not only will we trade too frequently, but we will also almost always do it at inopportune times: Why don’t we hold more of that asset that has outperformed everything else in the portfolio, has enjoyed huge tailwinds in recent years and is trading on stratospheric valuations?

—

The more we think about the standalone merits and performance of any given holding or ‘line-item’ in our portfolios, the less likely we are to make sensible, well-calibrated decisions and be appropriately diversified for an uncertain future. 

–

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).

The supine support offered to the new US President by multiple technology billionaires may be frustrating to some people but should be a surprise to nobody. They are responding to incentives, and incentives, more than anything else, drive behaviour. Our desire to understand and map the intricacies of human activity can sometimes lead us to overlook this inescapable truth. 

In his wonderful talk: ‘The Psychology of Human Misjudgement’, Charlie Munger states:

“I think I’ve been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power.”

Humans are, of course, wonderfully complex, intricate and often irrational beings, but in some ways we are simple and predictable – particularly when it comes to incentives. If we had to anticipate the behaviour of an individual or group, the one thing we would want to know, far more than anything else, is the incentives at play.

This raises the question – but what incentives? We can be motivated and incentivised by many things, but if we start with money and power (and everything related to those aspects) we are probably on safe ground.

Despite the importance of incentives, it still feels like a neglected subject. Corporations spend vast amounts of money and time trying to understand individual and team behaviour, with barely a passing reference to the thing that is inevitably driving most of it – incentives.

One of the central reasons that big groups struggle to make good decisions or large companies become woefully inefficient is because with size comes increasingly divergent and misaligned incentives.

Misplaced incentives can have a profound impact on society. The seeming inability of corporations and governments to favour long-term thinking over the prospect of short-term wins is largely an incentive problem. Neither the CEO focused on the market reaction to their company’s next set of results, nor the politician two years away from re-election have incentives that encourage taking a longer-term perspective.

If incentives are so important to our behaviour, why do we so often ignore their influence? An undoubted issue is that few of us are willing to admit that our choices are driven by such brazen and base things. We almost always cloak behaviour driven by incentives into some more fulsome and thoughtful justification to make it palatable – both to other people and ourselves.

A key element of behaviour change is shifting incentives. If we observe divergent behaviour then we should immediately check whether the incentives have altered. While if we want to promote new behaviours then incentives are the most effective place to begin.

The first question we should ask when we are considering anything to do with behaviour or decision-making is – how are people incentivised? The answer will explain a lot.

—

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).

Last week, I asked ChatGPT the following question: “Between 2018 and today, can you tell me what the major financial market worry was for each quarter?” Here was the response:

Reading through them all made me a little misty eyed about all the time spent in my career working on and worrying about issues that didn’t end up mattering that much (from an investment perspective, at least).

There is, however, a genuine problem here for investors. Financial markets tend to be an unstoppable conveyor belt of in-the-moment critical concerns that we cannot help but engage with, almost always in ways that are to our detriment.

It is human nature to be drawn towards things that are both salient and available. In financial markets, that means the more available (or prominent) an issue is, the more likely we are hugely overstate both its importance and the risk it presents.

Our engagement with this phenomenon typically works something like this:

Stage 1: A news story becomes the focus of investor / market attention.
Stage 2: We greatly overweight its long-term importance.
Stage 3: We develop ‘shallow expertise’ and a passable opinion on the subject.
Stage 4: We calculate our ‘exposure’ to the issue.
Stage 5: We inaccurately predict how financial markets will be impacted.
Stage 6: We either make a poor decision or have to justify not making one.
Stage 7: We move on to next in-the-spotlight news story.
Stage 8: We entirely forget what we said in Stage 1-6 within a few months.

For any investor with a reasonably long time horizon, attempting to ignore whatever the market is focusing on at any given point in time is the sensible (and most lucrative) approach. Unfortunately, this can be close to impossible. For three reasons:

– It is hard to ignore something when everyone else is paying attention to it.

– We are human and thereby exposed to the same risk perception biases as everyone else. We must work exceptionally hard to behave differently.

– Sometimes something will matter to financial markets in a material way and ignoring it won’t look smart.

The issue of something ‘mattering’ is an important one. Most high-profile stories will move financial markets in some way, but that does not mean it should be important to us. It should only really matter to us if it has a predictable, fundamental impact on how we are invested over a time horizon that is relevant. For most sensibly diversified investors this should be an incredibly high hurdle. 

If we are obsessing over short-term market fluctuations, it is critical to remember that these are predominantly the activities of investors with entirely different objectives to those that we have. They are talking a different language, one that we don’t need to be conversant in.

One way to help protect ourselves from being frequently dragged into the latest financial market fascination is to keep a log of what it is we are worrying about each month and what we think about it. Looking back on how often seemingly essential topics fade from view might just give us a slim hope of insulating ourselves in the future.

What has our gripped attention right now will probably matter just as much as that financial market fixation from last month and the one that arises next month. I can’t wait to find out what it is.

—

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).

In the latest episode of the Decision Nerds podcast, Paul and I discuss my final entry into the oblivion of Room 101 – investment technology. Choice, transparency and control are wonderful things for investors, but having the ability to react to every piece of financial market noise is a potential behavioural disaster with huge ramifications for our long-term returns.

We discuss why technological developments can facilitate bad behaviours, why nobody seems to care and what we can do about it.

The third of three short episodes is linked here and on all your usual podcast platforms.

Imagine it’s ten years ago and you are assessing the relative merits of market cap weighted exposure to US equities and an equally weighted allocation. Across a range of valuation metrics you can see that the equal weighted index is moderately cheaper. As luck would have it you also have a crystal ball that tells you that EPS growth will be greater for the equal weighted index over the next ten years. Same constituents, lower valuations and superior growth, that seems to be a great starting point for an equal weighted approach. So, what happened next?

Over the subsequent ten years the market cap index outperformed by close to 80%.

Investing is hard, and for many reasons:

Sensible decisions will frequently make us look stupid: It is not just that virtually all good long-term decisions will go through difficult spells; it is that seemingly prudent choices will often have negative outcomes and make us appear foolish.

Crystal balls aren’t enough: One of the inherent challenges of investment decision making is that the future is profoundly complex and uncertain. Our conviction must always be tempered by the vast amount we cannot and do not know. As the equal weight US equity example shows – even a glimpse of the future will often not be enough.

Sentiment can overwhelm everything: It is not just that it is hard to forecast future fundamentals, it is that anticipating fluctuations in sentiment is even more challenging. The underperformance of equal weighted US equities over the past decade has been driven by a transformation in the perceived prospects of the largest companies in the market.

A longer time horizon doesn’t guarantee success: Having a long time horizon is the greatest advantage any investor can have. (How long? As long as possible). Unfortunately, it is not enough to ensure a positive outcome. Although the impact of swings in sentiment fade with the passage of time, they can still exert a huge influence over periods longer than most of us can bear. A long-term mindset is still our best chance of success. It materially improves the odds, it just doesn’t provide anything close to certainty. 

Extremes matter: The psychology that drives financial markets means that prices tend to traverse periods of unbridled optimism and entrenched pessimism. Assets don’t always rest in an equilibrium state. This means that active views are probably best taken when those extremes are already evident – leaning against excesses is probably where the probability of success is greatest. Marginal active views (like equal weight versus market cap ten years ago) are too often beholden to the next unpredictable shift in sentiment.

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It is somewhat dispiriting to know that even if we had advance knowledge of critical equity market fundamentals, we would still likely look as if we had made an irrational decision. There are vital lessons that stem from this example, however. Most importantly that humility is the critical trait for all investors – we will frequently be wrong, and our actions and behaviour should reflect that. What is the best evidence of a well-calibrated, humble investor? Sensible diversification. 

Investing is hard and the future is uncertain. It should show in our portfolios.

—

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).

My first nomination for the Decision Nerds podcast Room 101 was a relatively gentle chart crime; my next investment industry pet hate to send into oblivion might be a little more controversial – it’s mutual fund performance fees.

What’s my problem? Well, such fee structures are often framed as better aligning client interests and fund manager incentives, when often they do no such thing. Rather they create a ‘heads I win, tails you lose’ asymmetry and one that is not (surprise, surprise) in the interests of the client.

You can find out a little more about my thinking, why Paul might disagree and how fees can be better structured.

The second of three short episodes is linked here and on all your usual podcast platforms.

There has never been a better time to be an investor. We have unprecedented choice, transparency and control. There has also never been a worse time to be an investor. We have unprecedented choice, transparency and control.

Although it may seem heretical, there is a strong case to be made that the evolution of the investment industry – in particular the wonderful technological advancements – has actually made life more difficult. Why? Because so little thought is given to the behavioural consequences of the profound changes we have witnessed. Indeed much of the technological progress we have seen threatens to turn investors into gamblers.

There are two elements that are central to short-term investor decision making – emotional stimulus and friction.

Emotional stimulus simply means that how we feel impacts and often overwhelms the choices we make. What the psychologist Paul Slovic might call the ‘affect heuristic’.

This could be fear, greed, anxiety, excitement, envy or a multitude of other things. The problem for investors is that we are engulfed by a constant barrage of financial market babble that inevitably provokes an emotional response. We can see how our portfolio performs minute by minute, we hear about the incredible successes of other investors on social media, we get bombarded with news about every market fluctuation. All of these things make us feel something, which often compels us to take action.

This might be harmless enough if it were it not coupled with another development – the removal of friction from our investment decision making.

Friction simply means how hard something is to do, and it is more powerful than we think. As Robert I. Sutton and Huggy Rao argue in their new book: ‘The Friction Project‘, we can get ourselves into big trouble by making the wrong things easy and the right things hard.

The issue for investors is that technological developments have made many things easy – checking portfolios and trading – but without careful consideration of the negative behavioural implications. Investors have ended up in a situation where we are overwhelmed by emotional stimulus and have no friction to stop ourselves reacting to it.

It is as if the industry has said – ‘humans are prone to costly behavioural mistakes, so let’s make them as easy as possible to make’.

Of course, it is hard for any investment provider to say to their clients – ‘we are going to make things harder for you because we don’t trust you to make sensible choices’, but at the very least stronger behavioural interventions and better guidance is a necessity.

In the UK, online gambling firms are subject to a range of requirements related to client behaviour in order to obtain a license. Tools such as deposit limits and time outs are required features. These act as behavioural checks and balances, imperfect certainly but at least acknowledging some of the unfortunate realities of human behaviour.

It is easy to say that investing and gambling are two different things, but they are not so distinct from eachother. Indeed, the exact same decision may be a gamble for one person and an investment for another.

Two people might buy the same amount of Apple shares, one for a long-term share of profits and the other because they think the company will beat earnings forecasts later that day. One decision feels like an investment and the other a gamble. The difference between the two can sometimes just be intent and opportunity.

The present environment for investors – defined by noise, emotional stimulus and an absence of friction – will almost certainly drag many of us away from investing and towards gambling, where our actions will be increasingly short-term and speculative with poor odds of success. This is in the interests of some in the industry but certainly not most investors.

This frictionless backdrop also makes how firms communicate more critical than ever. Flooding investors with incessant market comment might be okay if there is friction present. If it is hard to trade, then maybe what is said doesn’t really matter as it is all quickly forgotten. This doesn’t apply anymore. Anything that is communicated to investors might be acted upon. Nothing should be considered benign. We should always ask – how might what we are saying make an investor feel and what might they do about it?

I understand the theory about why today is such a fantastic time to be an investor and much of it is valid. I fear, however, that human nature might mean there has never been a worse or more dangerous time to be an investor.

It is probably time we took behaviour seriously.

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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).