What remains of our savings, after paying for our aged-care facility residence, is tied up in a thing called a ‘wrap’, in which our capital is invested over a wide range of equities, property and cash. I’ve never been especially interested in the money market, so the wrap works well for us. We get regular reports, and one of them contained a most interesting essay, whose point was that the biggest problem for investors might be the investor himself or herself. What followed was eerily familiar.
The problem is that all of us take short-cuts, or ‘heuristics’, that allow us to make decisions quickly and effectively. Effective they may sometimes be, but they also lead to cognitive biases that can trip us up, and lead to sub-optimal decisions and poor investment returns. Apparently there are over a hundred of these biases, and here are a few of them.
The Anchoring bias Here we rely on, or anchor to, a particular event, or a particular piece of information. The Global Financial Crisis (GFC), for example, led some investors to say something like ‘I won’t let that happen again’ when they look on what they did in consequence of the GFC. Or they rely on the purchase price of an asset relative to its history. We need to consider a wider set of anchoring points, or we are likely to become trapped.
Herd mentality Here we look to see what everyone else is doing, and follow the herd. What is important is to be aware of that likely bias, and ask yourself whether you are independent enough to make your own decisions for good reason. Yes, it can be hard, for you are going against the majority — and what if you are wrong? How embarrassing.
Confirmation bias Here we pay close attention to information that confirms our existing belief, and ignore information that contradicts it. This tendency leads to our watching particular TV channels that tell us what we like, and not to watch others, or to reject as ‘biased’ newspapers that take a different stance to our own. For investors this can be disastrous: they should be testing their initial view against whatever information they can find. For all of us, I think, it is better to have got things right than to be happy but wrong.
Overconfidence bias Here, characteristically, we attribute our successes to our innate talent and abilities, and put the losses down to sheer bad luck. We all have a tendency to overestimate our strengths and minimise our weaknesses. What we need is careful risk-management, I am acutely aware that a large part of my own success in life came simply from the coincidence of my birth year, 1937, the lowest Australian birth-rate in the 20thcentury, and the rapid expansion of the Australian economy as I came of age. We need the ability to distinguish skill from timing, or luck.
Loss aversion People with this syndrome dislike losing money much more than they enjoy making it. The GFC created for many people an enduring fear of a big loss, which turned them into conservative investors, likely to miss out on innovative upturns in the market. If you are investing you have to understand that there is a risk involved, and periods of negative returns are part of that risk. We should guard against both excessive risk and an imagined ‘riskless’ strategy.
What are our own biases? It is important, and not just with respect to investing, to be aware of our own biases, and critically examine our own positions where it is important to do so. The capacity to think independently, and to arrive at conclusions through reasoning, is the basis of successful investment and, I think, of a successful career in any field. Above all, we should aim for sound judgment and control over our emotions and other natural tendencies.
These cognitive biases are alive and well in the business of government policy. Ideally, public policies should advantage many more people than they disadvantage. In practice quite a number of public policies are instituted to help the party in power to win the next election, which is a form of self-interest. In the investment case, self-interest is assumed. I think it is worth considering how much other domains are affected by self-interest.
Take, for example, the legion of community-based organisations in the health area. They are commonly started by parents who lost a child to a particular disease, and they explain that they don’t want other parents to have to go through what they went through. They want money for research, and a strong body to get governments to listen and act. It sounds virtuous, and there is virtue in it. But there is also self-interest. I have been one of a group of Commonwealth superannuands who kept on urging government after government to use average weekly earnings (AWE) rather than the cost-price index (CPI) in adjusting our pensions for inflation. I cheerfully admit that our doing so was fuelled by straightforward self-interest.
There is a degree of self-interest, also, in the environmental NGOs. They are interested in more and more government action to curb land-clearing, to protect wildlife, to stop the building of dams, and in general to return the environment to what they feel it used to be before human beings despoiled it. It is not clear to me that these bodies are interested in the welfare of the ordinary Australian, and they are certainly not interested in the welfare of Australia’s farmers. Indeed, our agricultural industries are in decline, just at a time when it is plain not only that the world needs much more food, but that our country is a strong position to supply the world food market.
What drives the environmentalists? Ideology and success, I think. An ideology is a normative view of the world that is based to some degree on values. The ideological basis for environmentalists is a preference for the world of Nature over the world of human society. And success, because the environmental NGOs have been most successful over the past half-century. Our rivers and harbours are cleaner, there are lots more national parks, sheep and cattle numbers are way down, as are harvests over the past three years, for which drought is partly to blame. But our wheat production is only about double what it was in the 1960s. We need investment in agriculture, not environmental green tape.
The ‘climate change’ movement is similarly ideological. The alarmists say there is ‘no need for discussion’, ‘we need action’, and so on. Yet the science is not at all settled, and the dire forecasts of the future, which apparently terrify some children, are based on climate and economic models whose capacity to foretell the future is just about zero. If actions to ‘combat climate change’ are to be in the interest of ordinary Australians they need to be based on solid science, good evidence and good argument. In my judgment none of that is the case. What we have instead is shrill clamour and a total refusal to discuss the issues openly.
You can see all those biases in action in what passes for public policy, as well as in the matter of investment. It is such a pity, because we could do so much better, if governments were as interested in good public policy as they say they are.