How your brain tricks you (when investing)Posted on October 24, 2012
I was having a drink with a couple of friends over the weekend in Shanghai. You know the type, they are always smarter then you and everyone else. They knew the financial crisis was coming. That Ford wouldn’t go broke like GM. That the US equity market would zoom in 2009 in the middle of the recession. They knew it all.
I’m not picking on these guys though, for a very good reason. They are simply human. They suffer from the behavioral bias towards money we all do. It’s called Hindsight bias.
“But I don’t suffer from any irrational bias!” I hear you cry. How many people do you think are rational when it comes to money? Of course some people are emotional, but surely myself a fact based doctor/engineer/CEO is one of say 20% who are rational? Actually it is far less. It turns out that practically no-one is rational on financial decision making. No-one can remove emotions even if they tried (without brain damage that is). All decisions in uncertainty are made by the pre-frontal cortex – ie the emotional bit. Without that, and some poor people have had theirs removed, then we would fail and find it impossible to make a decision. Don’t think it’s all bad; some parts of the pre-frontal cortex are there for good reason.
My friends seemed to have a full brain (I think) and they had one small weaknesses in the argument. None had shorted the market prior to the financial crisis. None had sold-short GM. None of them had bought the market in early 2009 either. If they were so sure, then they would have done something, wouldn’t they? Of course they had reasons they claimed, but they weren’t the true reason. Their brains had tricked them. Our brains lie to us about what we know and when we ‘knew’ it. It’s probably related to cognitive dissonance and overconfidence bias also.
Hindsight bias is one of the key reasons (at least in my opinion) on why people don’t use financial advisers. They saw the financial crisis coming but most financial advisers didn’t (in their view). Don’t believe it, it’s just a brain trick. Unless you are consistently and getting excellent returns year after year in your share account and getting rich, you are just tricking yourself. Don’t allow any excuses “oh but for those two bad picks I would have done great”. Be hard on yourself like you are on anyone.
One of the key advantages of using a financial adviser is that it is much easier to be rational and disciplined with someone else’s investment. All the fear, anxiety, greed and everything is stripped away and only the investment decisions remain. For one of my clients, I have a success rate of almost 100% on equity selections (only one selection has lost money in the last 5 years and it wasn’t much) and he has made strong gains each year we have worked with very small volatility. Our partners found our own accounts were more volatile with poorer returns, so we actually manage the each other’s money. It has produced much better returns with less grey hairs. So much for the principal-agent problem being the cause of all that is bad in finance.
Of course hindsight bias isn’t the only one. There are about 20 biases that behavioural finance researchers like Daniel Kahneman have been able to prove and document. Anchoring bias (sticky house prices), illusion of control (Las Vegas), confirmation bias (Fox news), loss aversion bias (bank interest) etc.
Ultimately the theory shows that each is a result of evolution. Financial markets are too recent and therefore don’t fit with evolutionary impulses, hence the poor decisions. The tough aspect of this is my friends at the bar. Even with the help of hindsight, one or two seem completely untroubled by any noticeable effects of evolution. At least that’s what the girls sitting at the next table said… more or less.
About Caterer Goodman Partners
Caterer Goodman Partners is a Shanghai based wealth management firm established with a clear vision to provide a new level of personalized financial planning services for expatriates in Asia. Our financial advisors provide guidance for our clients in all areas of investment, specialising in managed accounts, money-market funds, retirement planning and alternative investments. At Caterer Goodman Partners, we offer our advice and experience to provide low cost, tax-effective and simple solutions to match our clients’ interests.
About Owen Caterer
Since graduation Mr Owen Caterer has worked with the Queensland Premier's Department in Trade Facilitation and then as a financial adviser in Shanghai from 2005 until 2010. He then rose to Senior Adviser, then Business Development manager and then to Chief Investment Officer responsible for portfolios to a value of US$280 million across Asia. Following that Mr Caterer left to found his own firm with a partner in the financial advisory and wealth management area. This focused on developing China and Asia's first fee-based financial advisory (rather than commission-based). This has grown to now have 8 staff and and managing almost US$35 million for clients throughout Asia. This business success was recognized as a finalist in the 2013 ACBA in the Start Up Enterprises category and are one of a small number of foreign managed firms to have a full asset management license in China. Owen has also been active in the community volunteering for the Australian Chamber of Commerce in Shanghai and acting as the Vice-Chair of the Small Business Working Group (2012-2014) and as the Co-Deputy Chair of the Financial Services since 2013 until the present. They have continued to grow their business and have now been selected as a small group of companies who are platinum members of the Australian chamber of commerce. The achievement they are most proud of is their efforts to reform the financial planning industry in China and push it away from a hard-sales commission driven model to a more ethical management fee and long term customer service model. Owen has a Graduate Diploma of Applied Finance from the Securities Institute of Australia of which he was a member as a Fellow of Finance for many years and also has an undergraduate degree from Griffith University in International Business. Owen's interests are tennis, running and his wife and two children. He speaks fluent Chinese, first arriving in China in 1997.
Tags: Behavioural Finance, Bias, Caterer Goodman, China, Expat, Financial Advisor, Hindsight, Investment, Money, Owen, Owen Caterer, Shanghai