By JOE WIGGINS
I started my investment career in 2004. Although equity markets had begun their recovery from the damage wrought by the dot-com bubble, the scars were still evident. All too regularly I saw client portfolios with tiny, residual holdings in once-celebrated technology funds — stark reminders of costly past decisions. With the wonderful clarity and confidence that only hindsight can bring, I remember thinking how I would never be swept up by such lunacy and, in any case, it was unlikely to happen again — investors will have learnt their lessons. One look at the all too recent obsession with ape JPEGs, made up currencies, (empty) shell companies and, once again, stratospherically valued technology businesses would tell you quite how naïve I was.
Why is it that we can have such vivid and painful investing experiences but go on to repeat the same mistakes?
The central problem for investors is about behaviour and stories. One of them changes and the other doesn’t.
Lessons not learned
GMO’s Jeremy Grantham was once asked what lessons investors would learn from the 2008 Global Financial Crisis, he replied: “In the short-term a lot, in the medium-term a little, in the long-term, nothing at all. That would be the historical precedent.”
Part of this phenomenon is down to the half-life of painful investment episodes. Memories fade and scars heal. There is also always a new set of younger investors, unburdened by the baggage carried by the previous generation — ready to learn the same lessons anew.
Yet this is not sufficient to explain the unerring cycle of mistakes. Most investors live through multiple spells of mania, greed, panic and despair. And, even if they haven’t, there is plenty to read about it. Despite the evidence, our behaviour doesn’t change.
Something really is different this time
The reason that it is so easy to discard the lessons of history is that the story is always fresh. We can reject the behavioural failings of the past as an irrelevance — this is a new situation and the old rules do not apply. Our focus is always on the persuasiveness of the narrative of the moment — it is how we interpret the world — rather than our behaviour.
Sir John Templeton’s famous comment about the danger to investors of the four words “this time it’s different” is absolutely true as it pertains to the nature of investor behaviour — that doesn’t alter. Yet our willingness and ability to repeat those poor behaviours arises only because the story is different each time.
The story changing allows our behaviour to remain the same.
Incentives ALWAYS matter
No discussion of investor behaviour can be complete without a consideration of incentives. New stories allow and compel us to ignore behavioural lessons, and incentives act to leverage this effect, exacerbating the disconnect.
Investment narratives are wrapped up in a virtuous/ vicious circle alongside performance and social proof. A captivating story, strong (or weak) performance and the behaviour of other investors creates a self-reinforcing loop, where one element validates the next. High (or low) returns seem to further corroborate the story and persuade more investors. And so it continues.
At some point most people get captured by the gravitational pull of this interaction. Whether it is the pain of poor performance, our neighbour making more money than us or the threat of losing our job. We become incentivised to behave poorly.
We don’t need everyone to believe in a story for it to overwhelm sensible investment behaviour, just enough so it becomes in almost everybody’s interest to go along for the ride.
Is our behaviour deteriorating?
Although our behavioural characteristics don’t change, there is a risk that the impact is becoming more severe. Why? Because there is more stimulus and more opportunity.
Financial markets are narrative generating machines. Not only does modern technology mean that we have more stories being created than ever, but they are effortlessly disseminated and amplified. Add to this the ability trade in an instant and we truly have a toxic behavioural concoction.
There are no easy solutions here. It is not simply that we do not learn from our investing mistakes, but that we are likely to make more of them.
It is undoubtedly harder than ever for investors to behave well.
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