Are you irrational when it comes to investment?
Our clients will be familiar by now with us talking about the importance of managing behavioural risk. It is one of a myriad of threats to the success of our clients financial plans and we are constantly thinking about how we can best help to manage it.
Behavioural finance is very much in vogue at the moment and there is some fascinating work being done in the field. One particularly interesting study I enjoyed reading about recently was around gambling with a loaded coin. Surely if you knew the coin was loaded 60/40 you are guaranteed to win in the end right?
What may be surprising to some is that when given real cash to gamble with, the 61 participants in the study were relatively unsuccessful, commonly employing irrational and inefficient strategies with a good proportion actually going bust! You can read more and find a link to the whole study here http://www.economist.com/blogs/buttonwood/2016/11/investing?fsrc=scn/tw/te/bl/ed/?fsrc=scn/tw/te/bl/ed/investingirrationaltossers
I did manage to reach the ceiling of $250 from my $25 start, however despite knowing the purely mathematical nature of the problem, it was somewhat sobering to consciously experience part of my brain making me second guess my strategy.
The exercise is a safe (no real money required!) and revealing way to experience these potentially wealth damaging emotions. The feelings experienced are closely linked to those which make some people cash in or change track when their portfolios hit a rocky patch. We know this is a huge destroyer of wealth and one of the most important things we can help our clients manage in our role as their personal finance directors.
Can you stay rational when the chips are down? Why not have a go yourself and let me know how you get on?