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Our need to be right makes us wrong
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CommentDecember 1st, 2008
November 24th, 2008
November 3rd, 2008
October 27th, 2008
Humans are well suited for many things. We have mastered language, conquered space, made the most of our opposable thumbs and infinite imaginations. We’re not good overcoming our own worst impulses — particularly as investors.
Last week I listened to a talk given by Dr. Ernie Ankrim, chief investment strategist for Russell Investments. Russell is the investment research firm that has given us the well-known Russell indexes.
Last week I listened to a talk given by Dr. Ernie Ankrim, chief investment strategist for Russell Investments. Russell is the investment research firm that has given us the well-known Russell indexes.
He said, “Our psychological makeup actually makes it difficult to adequately understand risk-reward tradeoffs. We are somehow wired to behavior that gives less-than-great results.”
He cited a study done by G. Wolford, M. Miller and M. Gazzaniga named “The Left Hemisphere’s Role in Hypothesis Formation.” The study compared humans against rats and pigeons.
He cited a study done by G. Wolford, M. Miller and M. Gazzaniga named “The Left Hemisphere’s Role in Hypothesis Formation.” The study compared humans against rats and pigeons.
After observing a series of lights, human subjects were asked to guess whether the next light would flash green or red. The red light flashed 80 percent of the time and the green 20 percent, in random order.
The non-human subjects were presented with red and green buttons randomly delivering food or a mild shock.
The non-human subjects were presented with red and green buttons randomly delivering food or a mild shock.
The rats and pigeons learned that if they picked red every time, they were rewarded 80 percent of the time. After a while, they picked red every time.
Humans tried to figure out the sequence. Humans were trying to be right 100 percent of the time and in fact, were poorer selectors than the rats and pigeons. If they were right 80 percent on red (.8x.8 equals .64) and 20 percent on green (.2x.2 equals .04), they were only right 68 percent of the time. Therefore, humans do worse than rats and pigeons on predicting random outcomes.
Our need to be right can make us wrong. Investment strategist use this theory to explain why many investors who try to “time” or “out think” the market have poorer results than those who simply consistently invest over time.
Many of studies have been done to prove that the average results of the overall stock markets have been far superior to the actual results of individual investors.
Humans tend to overreact to their emotional makeup. They react to the massive amount of investment “news” now available in the media. Those investors typically “buy high and sell low.”
Dr. Ankrim went on the say that “the brighter the investor, the more vulnerable they are to be correct.” Of course, this is especially to their detriment in the long run.
All we have to do is look at the investment activities of this last summer. When the stock market was extremely volatile, investors bailed out of the market by the billions of dollars, only to regret it in just a few weeks when the market rebounded. Who knows when to get back in?
Actual risk and return results can vary widely over short periods of time. This is the reason that investors must have long-term goals that override their knee jerk responses to short-term fluctuations.
So can we determine that it is better to be dumb and rich? No, not really. What we can determine is that we need to have a long-term strategy centered on long-term goals. We need to create a systematic investment strategy based on appropriate allocation of our assets into multiple investment categories that take advantage of both the up and downs in the market.
Also, we might conclude that we need trusted advisors who help us avoid our inclination to overreact to constant market volatility. We can do better than rats and pigeons and we must.
Tom Mills is a Registered Investment Advisor and Certified Financial Planner®. If you have questions or topics, call or write him at 1030 Seminary St. Suite D, Napa CA 94559, 254-0155, fax 254-0158 or e-mail suntrm@aol.com
Humans tried to figure out the sequence. Humans were trying to be right 100 percent of the time and in fact, were poorer selectors than the rats and pigeons. If they were right 80 percent on red (.8x.8 equals .64) and 20 percent on green (.2x.2 equals .04), they were only right 68 percent of the time. Therefore, humans do worse than rats and pigeons on predicting random outcomes.
Our need to be right can make us wrong. Investment strategist use this theory to explain why many investors who try to “time” or “out think” the market have poorer results than those who simply consistently invest over time.
Many of studies have been done to prove that the average results of the overall stock markets have been far superior to the actual results of individual investors.
Humans tend to overreact to their emotional makeup. They react to the massive amount of investment “news” now available in the media. Those investors typically “buy high and sell low.”
Dr. Ankrim went on the say that “the brighter the investor, the more vulnerable they are to be correct.” Of course, this is especially to their detriment in the long run.
All we have to do is look at the investment activities of this last summer. When the stock market was extremely volatile, investors bailed out of the market by the billions of dollars, only to regret it in just a few weeks when the market rebounded. Who knows when to get back in?
Actual risk and return results can vary widely over short periods of time. This is the reason that investors must have long-term goals that override their knee jerk responses to short-term fluctuations.
So can we determine that it is better to be dumb and rich? No, not really. What we can determine is that we need to have a long-term strategy centered on long-term goals. We need to create a systematic investment strategy based on appropriate allocation of our assets into multiple investment categories that take advantage of both the up and downs in the market.
Also, we might conclude that we need trusted advisors who help us avoid our inclination to overreact to constant market volatility. We can do better than rats and pigeons and we must.
Tom Mills is a Registered Investment Advisor and Certified Financial Planner®. If you have questions or topics, call or write him at 1030 Seminary St. Suite D, Napa CA 94559, 254-0155, fax 254-0158 or e-mail suntrm@aol.com
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petebo wrote on Oct 8, 2007 11:42 AM:
napawineo wrote on Oct 12, 2007 11:01 AM: