One of my favourite Daniel Kahneman quotes is: “Nothing in life is as important as you think it is while you are thinking about it”. It beautifully encapsulates our tendency to significantly exaggerate the importance of whatever is on our minds at any given moment. This is an issue that is particularly troublesome for investors. There is just one problem – the quote gets it wrong.
I am asleep in my bedroom one night when I am awoken by the sound of an alarm going off. I then see smoke creeping underneath the door. I quickly realise that there is a fire in the house and need to work out what to do next. Sometimes, just sometimes, events might be as crucial as we think they are when we are thinking about them.
We have a tendency to overstate the significance of whatever has our attention because – on rare occasions – it will be profoundly consequential. From an evolutionary perspective this makes perfect sense. Worrying a lot about things that might be a threat to our survival is a highly effective adaption. We can’t reproduce if we cannot survive.
Kahneman’s quote might instead have been: "The vast majority of things in life are not as important as we think they are while we are thinking about them”. Not as catchy, I grant you.
If nothing was ever as important, then we wouldn’t act as if a lot of things were. This gets at a core issue of why investing is so difficult. Many of the behaviours that have made humans such a successful species, also make it difficult to be good, long-term investors.
Our overreaction to short-term, visible, in-the-moment risks, is just one of them. There are plenty of others – including herding, aversion to losses, and our susceptibility to stories.
Discussion around investor behaviour often seems focused on creating a long list of detrimental biases that humans suffer from as if we are just a poorly wired species, ill-equipped to make good decisions. This is not the case – it is simply that certain ingrained behaviours that are incredibly effective in some contexts, can be detrimental in others.
That investment issue that you are currently worrying about is very unlikely to be as vital as you believe it to be, but it is very human to act as if it is. The key to good investment decision making is to understand what makes us human, and then to adapt those elements which might also make us bad investors.
Joe Wiggins is Director of Research at UK wealth manager, St James’s Place and publisher of investment insights through a behavioural science lens at www.behaviouralinvestment.com. His book The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions.
This article was originally published on Joe’s website, Behavioural Investment, and is reproduced with permission.