50 Reasons Why We Don’t Invest for the Long-Term

Investment is a long-term endeavour designed to meet our long-term financial objectives, so why do we spend so much of our time obsessing about the short-term and almost inevitably taking decisions that make us worse off?  Well, here are 50 reasons to start with:

1: Because it is boring.

2: Because markets are random and it’s difficult to accept.

3: Because of short-term benchmark comparisons.

4: Because we are remunerated based on annual performance.

5: Because of quarterly risk and performance reviews.

6: Because there is always something / somebody performing better.

7: Because we watch financial news.

8: Because we think we can time markets.

9: Because even good long-term investment decisions can have disappointing outcomes.

10: Because the fund we manage charges performance fees.

11: Because short-term losses are painful.

12: Because we forget about compounding.

13: Because we are obsessed with what is happening right now.

14: Because we are poor at discounting the future.

15: Because we will be in a different job in three years’ time.

16: Because we extrapolate recent trends.

17: Because we check our portfolios every day.

18: Because it is so easy to trade our portfolios.

19: Because we think poor short-term outcomes means that something is wrong.

20: Because we make decisions when we are emotional.

21: Because we think we can forecast economic developments.

22: Because we think that we know how markets will react to economic developments.

23: Because we compare our returns to the wrong things.

24: Because it is hard to do nothing.

25: Because regulations require that we must be notified after our investment falls by 10%.

26: Because it feels good to buy things that have been performing well.

27: Because there is too much information.

28: Because we don’t know what information matters.

29: Because we don’t want to lose our job.

30: Because nobody else is.

31: Because we need to justify our existence.

32: Because we think we are more skilful than we are.

33: Because we work for a listed company.

34: Because we don’t want to lose clients.

35: Because we think one year is long-term.

36: Because assets with high long-term return potential can be disappointing in the short term.

37: Because we think performance consistency is a real thing.

38: Because we don’t want to spend much of our time looking ‘wrong’.

39: Because the latest fad is alluring.

40: Because there is a new paradigm.

41: Because we vividly remember that short-term call we got right.

42: Because we can’t tell clients we haven’t been doing much.

43: Because we think we are better than other people.

44: Because we have to justify fees.

45: Because we don’t want to be invested through the next bear market.

46: Because we think short-term news is relevant to long-term returns.

47: Because short-term investing can be exciting.

48: Because we have to have an opinion.

49: Because there are so many experts and they are all so convincing.

50: Because it seems too simple.

Adopting a genuinely long-term approach to investment is one of the few genuine edges or advantages any investor can hope to exploit.  Unfortunately, it can feel as if everything is conspiring against our attempts to benefit from it – but that does not mean we should not try.


Is There A Behavioural Premium for Illiquid Investments?

I would like to make clear at the outset that this post is not about the attractiveness of illiquid asset classes – I will leave others to debate the merits (and drawbacks) of private equity and its counterparts – rather I am interested in the behavioural implications of illiquidity. I was reminded of the idea about there being some form of behavioural premium for illiquid investments whilst listening to this discussion between Cliff Asness and Patrick O’Shaughnessy; I also briefly mentioned this notion in my post questioning whether volatility equated to risk.

What do I mean by a behavioural premium? Let’s assume there are two identical assets, but one offers daily liquidity and is market priced, and the other is appraisal priced / valued and provides liquidity on an annual basis. I would contend that, on average, investors are likely to be better off (from a return perspective) in the less liquid structure over the long-term because of the implications for our behaviour.

Most of the behavioural problems that plague investors stem from our reaction to the fluctuations in price of an asset allied to our ability to freely trade it. It is almost certain that many of the benefits investors have witnessed in recent years in terms of greater control and transparency have come with a behavioural cost[i].  Of course, these issues relate primarily to liquid, regularly traded, market priced assets; illiquid investments have different features – two of which are particularly important when considering the implications for our investment decision making.

– Price volatility is reduced: Illiquid assets are typically valued on some form of appraisal basis, rather through than market pricing. This does not remove price volatility entirely but should lead to a significantly smoother return profile. Although we can argue about whether volatility is an adequate measure of risk, it seems irrefutable that the variability in the price of an investment influences our behaviour.

Whilst the underlying risk of an asset is not altered by the manner or frequency with which it is valued, volatility does matter. Not only does it provoke our behavioural biases (such as myopic loss aversion[ii]); but volatility is the fuel that feeds the fire of narratives that dominate our investment decision making. If we observe or experience reduced volatility, we are less likely to act because of volatility.

– Ability to trade is removed or restricted:  It is simply more difficult (by definition) to trade illiquid assets. With a liquid, market priced asset there is the ability to react immediately – this can be costly, particularly if our decision making is emotion-laden[iii].

For most investors a few sensible decisions are all that is required to have solid long-term investment outcomes, however, daily liquidity and easy access to our investments means that we are forced to make investment decisions perpetually – is my asset allocation correct? What about the recent fall in value of my portfolio? Should I reduce my equity exposure as there might be a recession ahead? Market movements incite an often overwhelming temptation to act, which technology and liquidity facilitate, increasing the potential for behavioural mistakes. Illiquidity (indirectly) forces us to make fewer decisions, potentially reducing the behaviour gap.

Of course, the idea of a behavioural premium for illiquidity is something of an abstraction – liquid and illiquid assets are distinct and we cannot perfectly isolate the behavioural impact of investments with different liquidity profiles.  Furthermore, an investment should never be selected on the basis of its liquidity or pricing methodology.

Investors, however, don’t have to invest in illiquid assets to capture such a behavioural premium; rather we can create a similar benefit with liquid investments simply by taking steps to reduce evaluation and decision making frequency – through making it harder to trade (limiting investment decisions) and checking portfolios less regularly (to reduce our ‘experienced’ volatility).  In an era of improved technology and access such actions can feel at best simplistic and at worst retrograde, but are crucial in making and sticking with sensible long-term investment plans.

[i] Hardin, A. M., & Looney, C. A. (2012). Myopic loss aversion: Demystifying the key factors influencing decision problem framing. Organizational Behavior and Human Decision Processes117(2), 311-331.

[ii] Benartzi, S., & Thaler, R. H. (1995). Myopic loss aversion and the equity premium puzzle. The quarterly journal of Economics110(1), 73-92.

[iii] Loewenstein, G., & Lerner, J. S. (2003). The role of affect in decision making. Handbook of affective science619(642), 3.

What Can Investors Do About Overconfidence?

Overconfidence can have a profound impact on our decision making, but can be difficult to acknowledge and even harder to rectify.  It also seems likely that overconfidence is a particularly pernicious bias in the investment industry, for the following reasons:

– Selection bias: There is probably a selection bias into front office investment management roles – that is overconfident individuals are more likely to ‘ascend’ to such positions.

Overvaluing overconfidence: Related to the prior point – overconfidence tends to be an effective career strategy. Against an uncertain backdrop we seem to value those who take bold and singular views, whilst being scornful of pragmatism, nuance and probabilities.

Overconfidence is easy: When operating in an environment marked by randomness and uncertainty it doesn’t take a great deal to make an overconfident decision.

The potential implications of overconfidence are significant and include: overtrading, lack of diversification, attribution error and a tendency to take positions with unfavourable odds – to name but a few.  Although there is no perfect remedy for overconfident decision making, there are certainly simple steps we can take to mitigate it.  These are my preferred measures:

1) Take the outside view:  This concept has risen to prominence in recent years, mainly thanks to Michael Mauboussin and Daniel Kahneman.  Taking the inside view relates to being reliant on your own individual experience and specific circumstance, whilst the outside view is based on evidence from a relevant reference group – what is the general experience from similar situations?

For example, assume you were considering investing in an active manager.  The inside view would be the great meeting that you held with manager, their impressive track record and pedigree of the team. The outside view would be that only 10% of active managers in the asset class have outperformed over the past decade. Absent the outside view, you would be liable to neglect the unfavourable odds of investing in the active manager and the level of overconfidence you may be exhibiting by doing so.

2) Think in probabilities and bets[i]:  Although we seem to have an unescapable desire for spurious precision and aggressive singular forecasts, we should resist these and instead think in terms of probabilities. Ascribing probabilities to different potential outcomes reduces the chance that we become wedded to a particular view, prevents us ignoring low likelihood risks and, crucially, leaves us free to alter our perspective when new information arrives.  Changing your position when you have made a strident, binary forecast is fraught with difficulty; adjusting probabilities is far easier.

3) Assume you are average:  A good check on any investment decision is to ask – should this decision work on average? Or, in other words, are the odds in my favour?  Try to take decisions where there is evidence that it is a sensible long-term decision – for example, favouring cheaper assets versus more expensive assets over the long-term. Taking such an approach can give an insight into how much reliant you are on your own skill for an investment view to come to fruition.

4) Think about who is making the decision:  Whilst there is an assumption that group decisions should be less impacted by overconfidence than solo decisions, this is not necessarily the case – a group comprised of similar individuals may be emboldened by the consistency of their views and display even greater overconfidence. Group composition matters. A recent study[ii] showed that diverse groups (from a gender perspective) were better calibrated than individuals and all male groups.  Although research in this area is nascent – diversity is likely to be a crucial consideration when thinking about overconfidence.

5) Carry out a pre-mortem: Pre-mortems are a simple means of dampening overconfidence[iii].  Before making an important decision, ask a group of people to imagine that you have implemented the decision and it has proved disastrous, then to list the possible reasons for the failure. This is a great way to encourage devil’s advocacy and break down hierarchical structures that may inhibit individuals from questioning the decision of their ‘superiors’.

6) Record and review decisions:  It sounds simple, but is so rarely done – make sure that you appropriately record decisions when they are made (including why you are making them) in order that you are able to assess the quality of your judgements in the future.  Rather than doing this, our tendency is to not consider past decisions at all, or review them with the benefit of hindsight and retrofit our rationale based on information we didn’t have at the time. Looking at historic decisions is difficult and shines a light on just how tough it is to operate in financial markets; but the feedback is invaluable. Always remember to review decision quality not outcome quality as unfortunately the two are not synonymous.


[i] Duke, A. (2018). Thinking in Bets: Making Smarter Decisions when You Don’t Have All the Facts. Penguin.

[ii] Keck, S., & Tang, W. (2017). Gender composition and group confidence judgment: The perils of all-male groups. Management Science.

[iii] Klein, G. (2007). Performing a project premortem. Harvard Business Review85(9), 18-19.

Twelve Investment Contradictions

The investment industry is a breeding ground for contradictions; our words, beliefs and behaviours are often in conflict with each other and sometimes themselves.   The causes of such discord are countless but include our unconscious biases, noise, insufficient knowledge and skewed incentives.  Below is a list of my current favourites, which will no doubt be different by tomorrow:

‘Data mining is a major problem for most quantitative investment strategies, machine learning is the future’

‘Volatility is a poor measure of risk for illiquid assets, but have you seen the Sharpe ratio impact of adding them to our portfolios?’

‘Diversity is at the heart of our culture, it just so happens that all our leadership positions are filled by white men’

‘We only want invest in high conviction, distinctive active managers…who consistently outperform’

‘We are acutely aware of the problem of return chasing in mutual fund selection …the first stage of investment process is a performance screen.’

‘We want to find investors who consistently apply their investment process and have the courage of their convictions, unless they perform poorly, and then we want them to do something about it’.

‘I expect to be making growing pension contributions over the very long-term, but want markets to increase in the short-term’

‘I am investing for the long-term, but like to check my portfolio valuation on a daily basis’

‘I want our non-equity positions to diversify our portfolio, unless equities are going up’

‘We are long-term investors but have 23 TVs showing financial news in our office’

‘I am happy to hold higher risk / higher return assets for the long-term, unless they go down in the short-term’

‘It is crucial to accept that randomness inherent in investment markets and take a probabilistic approach to any decision you make, but enough of that, let’s review three month performance’

Don’t Avoid the Simple Questions

For much of my career I have been involved in researching and recommending active fund managers; this process typically involves extensive due diligence including numerous face to face meetings.  Whilst optically the types of interaction that take place in these meetings appear straightforward, the underlying dynamics are complex and have significant implications for the type of questions we might ask about a potential investment.

A major impediment to our ability to obtain useful information and insights in such situations is our, often overwhelming, desire to manage how we appear to others.  We are prone to ask questions (or fail to ask them) because of how it may reflect on us, rather than because of the importance of the question itself.   In a previous job, I was often accompanied to fund manager meetings by the CIO (my boss) and the firm’s own psychologist.  My line of questioning was undoubtedly influenced by concerns about how I was being perceived by colleagues and also whether I had gained the respect of the fund manager that we were interviewing.

In terms of the ultimate goal of the meetings these issues were, of course, an irrelevance.  Whilst striving to appear intelligent in front of others might be a rational action from a career development standpoint, it can lead to incomplete and ineffective questioning.  I think there are two particularly problematic behaviours:

1) Asking questions to prove our competence:

There is nothing wrong with asking detailed, specific questions – they are an essential part of a thorough research process – however, there needs to be a purpose and you actually should be interested in hearing the answer.  Impressing a fund manager with sophisticated questions does not mean that you are doing a good job of assessing their investment approach.

A major hurdle for fund manager research is that you are typically at an informational disadvantage – the individual or team you are researching knows more about the central topic than you (or they certainly should do).  Testing the depth of a manager’s knowledge can be important provided it is relevant to their investment approach, but you should always be able to justify why you are asking a particular question.  Don’t mistake a fund manager knowing the securities in which they invest for being a skilful investor.

2) Not asking questions to avoid appearing incompetent:

This is a more pernicious problem and can lead to significant investment mistakes – asking ‘simple’ or ‘dumb’ questions can be painful and bruising to your ego, it can feel as if you are making a claim to be the least informed person in the room.  Although it is often hard to combat (particularly if you are relatively junior) you should attempt to ignore such feelings for a variety of reasons:

– Simple questions can be the most difficult to answer, particularly where complicated investment products are concerned.  It is easy to become lost in the weeds of an investment strategy and forget core principles that can often be drawn out by unassuming questioning.  Seemingly naïve enquiries can be both challenging and insightful (as any parent will attest).

– Other people in the room are probably interested in the answer. You are unlikely to be alone in wanting responses to simple queries, but you might be the only person willing to raise them.  I have sat in numerous meetings during my career when a fund manager has used a technical term or a particular acronym which (on reflection) none of their interlocutors fully understood, yet nobody asked for clarification – presumably because we were each working on the assumption that we were the only ones in the room at a loss.

– Answering foundation questions is a solid discipline for any investor.  A useful heuristic for us all is that if the essence of an investment approach cannot be distilled into elementary concepts, it is probably best avoided.

– If you fail to ask simple questions, there are likely to be significant gaps in your understanding about any given investment.   Apart from the aforementioned perceived reputational issues, there is very little downside to this type of questioning – it doesn’t have to come at the expense of more detailed lines of enquiry.

It is important not to confuse a simplistic question with a bad one – asking an active fund manager about performance drivers over the last month is a simple question, but on almost all occasions a poor one.  Effective yet simple questions are those that improve your understanding of how and why a strategy works, and clarify areas of complexity or uncertainty.

Although I have used the context of meetings with active fund managers, the issue of self-presentation and how it impacts the type of questions we ask is crucial across many domains. Whilst expertise around complex areas is rightly highly regarded, it is usually the simple things that define our success or failure.  Take care to manage your investments rather than your image.



The Worst Time to Buy an Active Manager

I have written previously about the central challenges of utilising active managers, namely:

  • There are few skilful managers and they are difficult to identify. The odds of successful selection are often stacked against us.
  • There are major behavioural challenges to owning the type of active managers most likely to deliver excess returns – those running distinctive, conviction-driven, high active share strategies. Even if we are able to find them, we are unlikely to persist with them through difficult periods.

There is also a third major issue and it relates to timing. Trying to successfully time anything in investment markets is a fool’s errand, albeit a very common and alluring one. The same applies to investing in an active manager – it is impossible to predict with any level of confidence when a particular manager or style will generate strong returns. However, whilst we may not be able to gauge when an active strategy will deliver, it does not follow that we should ignore the issue of when to invest in such a fund.

For example, if we assume that the average skilful manager can generate 2% annualised excess returns over the long-term*, investing in a fund following a three year period where it has outperformed its benchmark by 5% annualised has material implications for the likely path of future returns and the probability of success for our own investment.  Such a scenario means that even when we have made a strong manager selection decision (i.e. we have found a talented individual); it can still result in us holding an underperforming strategy if performance reverts towards the mean.

This issue is created by the fact that excess returns are uneven – a skilful manager will not generate consistent outperformance each year (unless they are incredibly lucky); there will be periods of feast and famine.  Whilst an accomplished manager is likely to deliver positive long-term outcomes, we might not enjoy the benefit during our ownership period.

To invest in an active strategy subsequent to a period of outstanding results we need to assume not only that we have found a manager with skill, but a truly exceptional individual that can produce and sustain returns well beyond what we might typically expect, even if our reference class is only that rarefied group of skilful managers. When making such an investment decision it is crucial to be acutely aware of the assumptions being made and the base rates potentially being ignored.

I always find it troubling that we feel more comfortable investing in a fund that has very strong performance before we invest – this is other peoples’ alpha, returns that we will not be receiving when we buy the strategy**.  That we have not benefitted is a negative, not a positive.

The ideal scenario is to identify a manager that possesses skill and invest following a spell of weak performance, but this is a rare occurrence.  As we overweight the importance of outcomes and tend to greatly understate the role of randomness in financial markets; we associate poor relative returns from an active manager with a broken or flawed investment process.  Persuading clients and colleagues that investing in an underperforming fund is a prudent course of action can be a herculean task. The reputational risk is also great – buying a strongly outperforming fund that then deteriorates is acceptable and common, buying an underperforming fund that keeps getting worse is unconscionable.

Although we cannot forecast when an active strategy will work, the timing of an investment can materially alter the odds of success.  Even if we find a skilful manager, our propensity to buy after periods of abnormally strong performance can still lead to poor outcomes.

* For long-term, let’s assume ten years. The average return of successful active managers will vary by asset class.

** Understanding how a manager has delivered outperformance and whether the positions / factors that are the most meaningful contributors to returns still feature in the portfolio is an important aspect of such analysis.

Investors Should Assume That They Are No Better Than Average

Overconfidence bears the traits of many behavioural issues within investment – it is widely known, poorly understood and assumed to affect other people.  Most of us are probably overconfident that we don’t exhibit overconfidence.  Although there are memorable examples of overconfidence in action – such as the majority of people in a room believing they are an above average driver – there seems limited acknowledgement of what forms overconfidence can take or how it can influence our decision making.

The investment industry should be a fruitful area for identifying and understanding overconfidence.  For a start there is an inevitable selection bias, I think it is safe to assume that the majority of individuals working in front office asset management roles exhibit more confidence in their own abilities than the general population.  Furthermore, many investors engage in activities that are ripe for displays of overconfidence – economic forecasting and market timing (to name just two) are key pillars of the industry, despite limited evidence of their efficacy.

In the investment world overconfidence is a sought after characteristic.  In an environment defined by uncertainty, we crave certainty, conviction and confidence (however ill-placed this might be); whereas circumspection, probabilities and caveats are associated with having a lack of knowledge or expertise. Thus, even if being well-calibrated is likely to improve your judgement, it will not necessarily have a similarly positive effect on your career prospects.

Whilst overconfidence is frequently discussed, there remains vagueness around what is actually meant by it; research by Moore and Healy (2008) sought to clearly distinguish distinct types of overconfidence*, defining these as: overestimation, overplacement and overprecision.

Overestimation: This is an overly optimistic view of our abilities or performance level.  For example, we are likely to exaggerate the success of our investment decisions.  As Moore and Schatz (2017) highlight, there appears to be a pattern where individuals overestimate their abilities on difficult tasks and underestimate on easy tasks. Investment would certainly fall into the former category.

If investors are overconfident about their performance level, what would be the benefit of such self-deception? One reason might be to manage the potential cognitive dissonance of believing yourself to be an intelligent and skilful investor, whilst simultaneously adding little value in your investment decision making – embarking on a career where you are no better than average may not be particularly fulfilling.  Of course, such overestimation by investors might not be self-deception at all, but rather an effort to present oneself to others (clients and colleagues) in the most favourable light.

Overplacement:  This is the classic ‘better than average’ perspective.  Despite a litany of evidence on this phenomenon, Moore & Schatz (2017) highlight some limitations with the research in this area – most pointedly the fact that a skewed distribution can result in the majority of individuals in a sample being above average. They also argue that, unlike overestimation, overplacement occurs more for easy tasks with underplacement more common for difficult tasks.

Given that the investment industry is highly competitive and involves lots of people undertaking ostensibly the same tasks, my sense is that over-placement must be pronounced. Indeed, it might be something of a pre-requisite – if you are below average at active management or as an economist then there is seemingly not a great deal of purpose in that particular role.  That is unless you take the view that there is so much uncertainty and randomness in investment that you can be aware that you are below average whilst pursuing a successful and well-rewarded career.

It may simply be the case that overplacement is somewhat irrelevant for asset management.  It is perhaps so difficult to disentangle luck from skill, that nobody knows what the distribution of skill is or where they (or anybody else) falls within it with any sense of certainty.

Overprecision: This is exaggerating our knowledge of the truth, and is typically tested through calibration studies. For example, answering a selection of questions (such as estimating the length of the Amazon River) whilst employing a 90% confidence interval. Success rates are typically far lower than the prescribed confidence level.

Overprecision would seem to be the most pervasive and pernicious form of overconfidence apparent in investment. Despite the inherently unpredictable nature of financial markets there is still an over-reliance on point forecasts, bold predictions and heroic portfolio positioning.  The use of subjective probabilities around potential outcomes is also something of a rarity.

One way to address the issues of overconfidence is to talk more explicitly about confidence levels, probabilities and base rates when making decisions. Let’s take an example:

I decide to invest in an active equity manager and have based that choice on the manager’s strong historic track record, robust process and compelling investment philosophy – we can call this the inside view (evidence specific to this circumstance).  Alongside this I must also strongly consider a base rate for active manager outperformance – in this instance over the last decade only 20% of the manager’s peer group have delivered performance in excess of the benchmark – we can think of this as the outside view (evidence incorporating a broader reference class).

To persist with recommending an active manager despite the base rate information means one of two things:  i) I believe the base rate is anomalous and in the future the proportion of managers outperforming in this sector will increase, ii) I believe that my active management selection capabilities are sufficiently strong that I am willing to accept the highly unfavourable odds of identifying an outperforming manager (even before considering mean reversion in performance).

This is not to suggest that in these situations one should never go against the base rate, but rather it is critical to consider these factors when making such a decision. Failure to do so means we neglect crucial information, largely ignore probabilities and have no means of understanding the level of (over)confidence underpinning our decision making

For most investors it is sensible to make investment decisions on the assumption that our abilities are no better than average. We can do so by answering two questions:

1: Assuming I have no skill, what is the probability of a successful outcome?

To clarify the purpose of this question, I can make an adjustment to my earlier example – let’s assume that there was an asset class in which active management had historically been particularly successful and 70% of active managers had outperformed the index over the past decade. In such an instance, the odds of a positive outcome from selecting an active manager are in your favour (other things being equal) even in the absence of any particular skill in manager selection.  This approach could apply to assumptions about future returns or, from a bottom-up perspective, company growth rates or margins.  Whilst there might not be a perfect reference class or probability number for every investment decision, it remains a worthwhile exercise.  

2: If I am taking a position where the odds are unfavourable, where do I hold a particular edge / skill and why?

When we take views that implicitly or explicitly reflect a high level of confidence in our own abilities, we should be clear about why this is the case. This is useful both for any given decision and also as a means of tracking decision rationale (and confidence) through time.  

Overconfidence is a major issue for investors and can create a plethora of costly problems, such as insufficient portfolio diversification and overtrading.  If, however, we think about our investment decisions on the basis that our skill is no better than average, we are far more likely to consider crucial factors such as base rates and put our own confidence levels into perspective. This is not a cure all solution for overconfidence, but should encourage us to make investment decisions when the odds are in our favour.

* I was reminded of this research by Jason Collins’ excellent blog.

Key reading:

Moore, D. A., & Healy, P. J. (2008). The trouble with overconfidence. Psychological review115(2), 502.

Moore, D. A., & Schatz, D. (2017). The three faces of overconfidence. Social and Personality Psychology Compass11(8), e12331.

Pulford, B. D., & Colman, A. M. (1996). Overconfidence, base rates and outcome positivity/negativity of predicted events. British Journal of Psychology87(3), 431-445.