Investor Health Check - Part 2 of 3

Are you suffering from any of these common investor blind-spots?

In Part 1 of this three-part series, we looked at two of the five common 'blind-spots' suffered by investors that will jeopardise long-term investment success.

This list of 'blind-spots' has been summarised from the work of Daniel Kahneman, an eminent psychologist and Nobel laureate, notable for his work on the psychology of judgment, decision-making, and behavioral economics.

Below we discuss 'blind spots' number 3 and 4; 'Price Myopia' and 'Hindsight-Expert Affliction".

3. Price Myopia

Daily movements in the S&P/ASX 300 accumulation index indicate that returns on shares are negative 46% of the time and positive 54% of the time.

Investors who monitor their share investments daily will experience many disappointments. Consequently, they may be discouraged from investing in shares.

Monthly monitoring may also unnerve some investors, because returns are negative one month in three and the average loss is about the same magnitude as the average gain, -3.0% and +3.3% respectively.

However, annual returns provide a more attractive picture, with losses occurring only one year in seven and the average gain of 15.7% being much larger than the average loss of -3.1%.

The lesson is clear: when viewed over short time frames, share returns appear much less attractive than they do when viewed over longer periods.

One should thus avoid monitoring their investment results too frequently, lest they become discouraged by the frequent incidence of losses.

... "The earliest version of the Quotron required that you type in a stock symbol and push the enter button before the current price would appear ... Later versions, display an entire portfolio and the prices for all the stocks, which are updated automatically as the day's trading progresses."

"The blank screen was a better system because you couldn't stare at it all day and watch your stocks go up and down ... When I got a newfangled Quotron, i had to turn it off because it was too exciting (distracting)."

"This is one of the keys to successful investing: focus on the companies, not on the stocks."

- from "Beating the Street", by Peter Lynch, arguably the most successful fund manager of our time.

4. Hindsight-expert affliction

Are you sure that you can accurately recollect your beliefs on the day before an event?

If you can perform this task accurately, you are in the minority.

Psychological evidence indicates that people can rarely reconstruct, after the fact, what they thought about the probability of an event before it occurred. Most are honestly deceived when they exaggerate their earlier estimate of the probability that the event would occur.

Because of hindsight bias, events that the best-informed experts did not anticipate often appear almost inevitable after they occur. Financial punditry provides an unending source of examples.

Within an hour of the market closing every day, experts can be heard on the radio explaining with high confidence why the market acted as it did. A listener could well draw the incorrect inference that the behavior of the market was so reasonable that it could have been predicted earlier in the day.

If the behavior had been predictable, of course, the event would have caused many people to change what they were doing - and the market would have behaved differently.

Everyone who deals with market events is familiar with this 'illusionary' chain of reasoning, but the fascination with interpretations of the past persists.

As Warren Buffett has commented, "Anyone can be an expert when observing from the rear-view mirror. Our requirement as investors however is to make rational decisions while looking through the windscreen."

Hindsight bias is dangerous in two ways:

First, hindsight tends to promote overconfidence, by fostering the illusion that the world is a more predictable place than it is.
Second, hindsight often turns reasonable gambles into foolish mistakes in the minds of investors. After a stock has dropped in value, its fall appears to have been inevitable. So why didn't my advisor suggest selling it earlier?

Further, the making of an apparent mistake can lead to the next affliction - "Regret paralysis". We will explore this final common investor 'blind-spot' in the the next issue of the Eden Wealth Report.

Daniel Kahneman - Nobel laureate

Daniel Kahneman is an eminent psychologist and Nobel laureate, notable for his research and insight into the psychology of judgment, decision-making, and behavioral economics.

His body of work is fascinating, and you can read more about Daniel at the Nobel Prize offical website.

Below is an extract from Daniel's autobiography:

"In one experience I remember vividly, there was a rich range of shades. It must have been late 1941 or early 1942. Jews were required to wear the Star of David and to obey a 6 p.m. curfew. I had gone to play with a Christian friend and had stayed too late. I turned my brown sweater inside out to walk the few blocks home.

As I was walking down an empty street, I saw a German soldier approaching. He was wearing the black uniform that I had been told to fear more than others - the one worn by specially recruited SS soldiers. As I came closer to him, trying to walk fast, I noticed that he was looking at me intently. Then he beckoned me over, picked me up, and hugged me.

I was terrified that he would notice the star inside my sweater. He was speaking to me with great emotion, in German. When he put me down, he opened his wallet, showed me a picture of a boy, and gave me some money. I went home more certain than ever that my mother was right: people were endlessly complicated and interesting."

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