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."

PROMOTED VIDEO
Life and Style
techCould new invention save millions in healthcare bills?
Sport
David Moyes gets soaked
sport Moyes becomes latest manager to take part in the ALS challenge
Voices
A meteor streaks across the sky during the Perseid Meteor Shower at a wind farm near Bogdanci, south of Skopje, Macedonia, in the early hours of 13 August
voicesHagel and Dempsey were pure Hollywood. They only needed Tom Cruise, says Robert Fisk
News
peopleEnglishman managed quintessential Hollywood restaurant Chasen's
Life and Style
food + drinkHarrods launches gourmet food qualification for staff
Arts and Entertainment
Michael Flatley prepares to bid farewell to the West End stage
danceMichael Flatley hits West End for last time alongside Team GB World champion Alice Upcott
News
ebooksAn evocation of the conflict through the eyes of those who lived through it
Life and Style
Horst P Horst mid-fashion shoot in New York, 1949
fashionFar-reaching retrospective to celebrate Horst P Horst's six decades of creativity
News
Members and supporters of the lesbian, gay, bisexual, transgender (LGBT) community walk with a rainbow flag during a rally in July
i100
Life and Style
Black Ivory Coffee is made using beans plucked from elephants' waste after ingested by the animals
food + drinkFirm says it has created the "rarest" coffee in the world
Arts and Entertainment
Jamie T plays live in 2007 before going on hiatus from 2010
arts + entsSinger-songwriter will perform on the Festival Republic Stage
Life and Style
food + drinkThese simple recipes will have you refreshed within minutes
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

C#.NET Server Side Developer (C#, XML, WCF, Unit Testing,SQL)

£30000 - £40000 per annum + benefits+bonus+package: Harrington Starr: C#.NET ...

Junior Database developer (SQL, T-SQL, Excel, SSRS)

£20000 - £30000 per annum + benefits+bonus+package: Harrington Starr: Junior D...

Business Analyst - Banking - London - £550 - £650

£550 - £650 per day: Orgtel: Business Analyst - Traded Credit Risk - Investmen...

Data Centre Engineer - Linux, Redhat, Solaris, SAN, Puppet

£55000 per annum: Harrington Starr: A financial software vendor at the forefro...

Day In a Page

All this talk of an ‘apocalyptic’ threat is simply childish

Robert Fisk: All this talk of an ‘apocalyptic’ threat is simply childish

Chuck Hagel and Martin Dempsey were pure Hollywood. They only needed Tom Cruise
Mafia Dons: is the Camorra in control of the Granite City?

Mafia Dons: is the Camorra in control of the Granite City?

So claims an EU report which points to the Italian Mob’s alleged grip on everything from public works to property
Emmys look set to overhaul the Oscars as Hollywood’s prize draw

Emmys look set to overhaul the Oscars as Hollywood’s prize draw

Once the poor relation, the awards show now has the top stars and boasts the best drama
What happens to African migrants once they land in Italy during the summer?

What happens to migrants once they land in Italy?

Memphis Barker follows their trail through southern Europe
French connection: After 1,300 years, there’s a bridge to Mont Saint-Michel

French connection: After 1,300 years, there’s a bridge to Mont Saint-Michel

The ugly causeway is being dismantled, an elegant connection erected in its place. So everyone’s happy, right?
Frank Mugisha: Uganda's most outspoken gay rights activist on changing people's attitudes, coming out, and the threat of being attacked

Frank Mugisha: 'Coming out was a gradual process '

Uganda's most outspoken gay rights activist on changing people's attitudes, coming out, and the threat of being attacked
Radio 1 to hire 'YouTube-famous' vloggers to broadcast online

Radio 1’s new top ten

The ‘vloggers’ signed up to find twentysomething audience
David Abraham: Big ideas for the small screen

David Abraham: Big ideas for the small screen

A blistering attack on US influence on British television has lifted the savvy head of Channel 4 out of the shadows
Florence Knight's perfect picnic: Make the most of summer's last Bank Holiday weekend

Florence Knight's perfect picnic

Polpetto's head chef shares her favourite recipes from Iced Earl Grey tea to baked peaches, mascarpone & brown sugar meringues...
Horst P Horst: The fashion photography genius who inspired Madonna comes to the V&A

Horst P Horst comes to the V&A

The London's museum has delved into its archives to stage a far-reaching retrospective celebrating the photographer's six decades of creativity
Mark Hix recipes: Try our chef's summery soups for a real seasonal refresher

Mark Hix's summery soups

Soup isn’t just about comforting broths and steaming hot bowls...
Tim Sherwood column: 'It started as a three-horse race but turned into the Grand National'

Tim Sherwood column

I would have taken the Crystal Palace job if I’d been offered it soon after my interview... but the whole process dragged on so I had to pull out
Eden Hazard: Young, gifted... not yet perfect

Eden Hazard: Young, gifted... not yet perfect

Eden Hazard admits he is still below the level of Ronaldo and Messi but, after a breakthrough season, is ready to thrill Chelsea’s fans
Tim Howard: I’m an old dog. I don’t get too excited

Tim Howard: I’m an old dog. I don’t get too excited

The Everton and US goalkeeper was such a star at the World Cup that the President phoned to congratulate him... not that he knows what the fuss is all about
Match of the Day at 50: Show reminds us that even the most revered BBC institution may have a finite lifespan – thanks to the opposition

Tom Peck on Match of the Day at 50

The show reminds us that even the most revered BBC institution may have a finite lifespan – thanks to the opposition