Investment: Self-knowledge is the key to success

TO BE brought face to face with one's own inadequacies is never comfortable but, when it comes to investing money, there is a strong case for saying that knowing your own capabilities (or lack of them) is at least as important as technical skills, such as the ability to read a balance sheet, or to calculate rates of return.

The importance of temperament was certainly one of the conclusions that emerged two years ago when I carried out an in-depth study of what it was that made the small handful of exceptional UK professional investors stand out from the crowd.

This is reinforced in Profits without Panic, a new book by Jonathan Myers, a New York psychologist. He pulls together the various strands of research that have tried to link the way people invest with the way they control their emotional and behavioural responses to money.

Few of us are blessed with temperament and self-discipline to do exceptionally well at investment.Neither, so it happens, are many professional investors. We are allsubject to mental biases that lead us to make what Mr Myers calls "systematic errors" - many of which are easier to understand than they are to cure.

Pointing out that even the likes of George Soros make huge gaffes from time to time, he quotes Niels Bohr's definition of an expert: "A man who has made all the mistakes which can be made in a very narrow field."

Here is one example of how wayward investors can be: a psychologist at Harvard University, Paul Andreassen, studied whether two groups of investors behaved differently. One was presented with simulated news stories that attempted to explain why a market or share price had risen, while the other group was not.

Which group did better? Thegroup without any information. They tended to buy as prices fell and sell as prices rose, relying purely on the value of the bargain they were being offered.

The group with the advantage of the news coverage was far less successful. They traded less accurately because they regarded the explanations they read in the news coverage as validating the way in which prices were moving, rather than merely describing it.

Anyone who has worked in daily newspapers will know that it is virtually impossible to avoid attributing a sharp movement in the market to some external cause, such as the Asian crisis or the opinion polls. You have to find good news to justify a rise, and bad news a fall, even though the explanation is invariably more complex than a simple good/bad juxtaposition suggests.

A similar problem arises with what psychologists call "preferential bias", the phenomenon by which once something about a potential investment has caught your eye, you tend to look for information that validates your initial feeling and ignore evidence that might point you in the opposite direction.

This, suggests Myers, might be why, having become interested in, say, a unit trust with a good performance record, investors so often ignore the fact that it also has exorbitant sales charges and commissions that effectively wipe outany advantage the superior performance bestows.

This would certainly help to explain why the introduction of "reduction in yield" illustrations on pension policies and unit trusts seem to have made so little impact on investor choice since the introduction of compulsory disclosure a few years ago.

And then there is the "hot hand" phenomenon, identified in research by Kahneman and Twerski, which demonstrated that even professionals continued to believe in trends that they had observed but which had no statistical validity. The research was conducted into basketball, where participants all believed that players in the middle of a long run of scoring (a "hot hand") were more likely to score than to miss with their next shot.

Yet the statistical evidence clearly shows that this is not the case. It is an illusion, as is the "hot hand" concept in fund management.

Faced with all this evidence, how are you to survive? The answer, says Myers, is to control your emotions and become aware of what you can and cannot realistically hope to achieve in the investment world.

Those who get that far can then try and profit by exploiting the evidence of other investors' mistakes (by selling popular fad stocks, for example, and buying shares suffering from a surfeit of public gloom - Marks & Spencer being a classic recent example).

The trouble is, of course, if it were really that simple, we would all do it. At the moment, in particular, the markets seem to be suffering from a clear case of what Myers calls "stability bias". This is the tendency for people to assume that if something persists for a number of years, it somehow becomes a reliable norm. The recent strength of Wall Street and to a lesser extent the UK market is a classic example of this phenomenon.

Equity returns cannot continue at their current levels in real terms; even Jeremy Siegel, the American professor whose book emphasising the consistency of long-run equity returns helped to set the great US bull market running, now says as much.

But is anyone really listening? Myers suggests not : "In a bull market internal personal reasons, fuelled by hope, are relied on to account for success and everything else is, consciously or subconsciously, dismissed as irrelevant."

Start your day with The Independent, sign up for daily news emails
News
ebookA unique anthology of reporting and analysis of a crucial period of history
News
peopleMathematician John Nash inspired the film Beautiful Mind
News
Richard Blair is concerned the trenches are falling into disrepair
newsGeorge Orwell's son wants to save war site that inspired book
Life and Style
Audrey Hepburn with Hubert De Givenchy, whose well-cut black tuxedo is a 'timeless look'
fashionIt may be a paradox, but the industry loves it
Arts and Entertainment
The pair in their heyday in 1967
music
Life and Style
fashionFrom bathing dresses in the twenties to modern bikinis
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Guru Careers: Software Developer / C# Developer

£40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

Neil Pavier: Management Accountant

£45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

Sheridan Maine: Commercial Accountant

£45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

Laura Norton: Project Accountant

£50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

Day In a Page

Abuse - and the hell that came afterwards

Abuse - and the hell that follows

James Rhodes on the extraordinary legal battle to publish his memoir
Why we need a 'tranquility map' of England, according to campaigners

It's oh so quiet!

The case for a 'tranquility map' of England
'Timeless fashion': It may be a paradox, but the industry loves it

'Timeless fashion'

It may be a paradox, but the industry loves it
If the West needs a bridge to the 'moderates' inside Isis, maybe we could have done with Osama bin Laden staying alive after all

Could have done with Osama bin Laden staying alive?

Robert Fisk on the Fountainheads of World Evil in 2011 - and 2015
New exhibition celebrates the evolution of swimwear

Evolution of swimwear

From bathing dresses in the twenties to modern bikinis
Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine