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I’ve seen very smart, very wealthy people make some very silly financial mistakes. In my experience, the source of these mistakes is not ignorance or lack of knowledge. It’s emotion. And if we understand our emotional biases –and how to manage them – we can become better investors. (Vadim Balantsev/Photos.com)
I’ve seen very smart, very wealthy people make some very silly financial mistakes. In my experience, the source of these mistakes is not ignorance or lack of knowledge. It’s emotion. And if we understand our emotional biases –and how to manage them – we can become better investors. (Vadim Balantsev/Photos.com)

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There are two sides to investing:

  • the numbers: the performance data and other measurable information;
  • the people: the investors who make the decisions that drive the data.

Myself, I’ve always been more fascinated in the latter. It’s my belief that when it comes to investing; people (or to be more specific, their behaviour) matters just as much as numbers and analysis. And maybe even more so.

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In the real world, markets are shaped by the biases, beliefs, fears, and hopes of all participants. I’ve seen very smart, very wealthy people make some very silly financial mistakes. In my experience, the source of these mistakes is not ignorance or lack of knowledge. It’s emotion. And if we understand our emotional biases –and how to manage them – we can become better investors.

Recently I had the pleasure of talking to Carl Richards about this topic. Richards is the bestselling author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money. He’s also written a finance column in the New York Times for a number of years, explaining investment and personal finance concepts on the back of cocktail napkins. He’s also been an invited guest presenter at various TIGER 21 functions, and very well received.

Richards is a nice guy to talk to, but when he talks about money mistakes, he doesn’t pull any punches. In his book, he outlines a very straightforward, very compelling idea: it’s our behaviour that determines a large part of our investment returns.

“We have to understand: emotion plays a huge role in investing and money generally,” he told me. “Because when you get underneath it, it’s about the most important things in our lives. Fear and security, and our homes and our kids’ future. All of that stuff is insanely emotional.”

I asked Richards whether he thought high-net-worth investors were better at this–whether people with money better able to handle the emotions of money. He doesn’t think so.

“There’s no question – in fact, I’d love it if you made this point super-clear – this is not a function of net worth, or even of experience,” he said. “You think that because you were able to build, you know, a cookie business, and to sell it for $20-million, you somehow have an ‘S’ painted on your chest when it comes to [investing].” Not necessarily true.

I agree. At the same time, I told Richards that this idea isn’t new. People like Warren Buffett have been saying for a long time that when it comes to investing, it’s not about how smart you are – it’s how strong your stomach is. Richards laughed. “It’s crazy, right?” he said. “This [advice] has been around for a long time.” And yet it’s followed much less than you’d think.

“I think maybe it’s no fun to do it the right way,” he said. As Richards explained, controlling your behaviour isn’t nearly as exciting as picking the next Apple Inc.. “It’s really, really boring. And for a lot of people, [investing] is part of a game.”

OK, so how can we close the behaviour gap? How can we take the emotion out of investing, and stop making dumb decisions with our money? Here are some ideas:

Ask yourself “Why?”

Richards believes everything in your portfolio should have a reason for being there. I agree. If you or your key advisers can’t articulate why a particular investment is in your portfolio, it probably means you haven’t taken the time to formulate a cohesive investment and financial plan.

“Make sure you can answer that question: why is your money invested the way it is?” Richards told me. “Once you have the answer to that question, only make changes when the answer to that question changes – when the why changes, not when the market changes.”

Have a bias for inaction

Richards is taking a page out of Warren Buffett’s book here. When investors jump into and out of markets frequently, they’re asking for trouble. A “buy-and-hold but closely monitor ethos” keeps us from making dumb mistakes.

Not that buy-and-hold means buy-and-never-sell. “Most of the time–just believe me, drill it into your head – changes are going to work against you,” Richards explained. “I didn’t say all. I said most.” The secret to investment success lies in knowing the difference.

Look before you leap

Throughout our conversation Richards emphasized the need for sober second thought. Before pulling the trigger on an investment, or on a change to an investment, you need to stop, wait, and think about what you’re about to do. “The more you delay a decision, the better a decision you’re going to make,” Richards says. “You should not be invested in any way that requires you to get out now.”

I think this is very good advice. If you’ve taken care of the “why" – that is, you’ve built your portfolio on goals – there should be very little reason for frequent trading.

“Get someone between you and stupid”

I love the way Richards puts this. He makes a very good point. Even expert investors need to find someone who can function as a sounding board or even as a “counter-point.” Someone who can play devil’s advocate when needed, and can talk you out of potentially stupid oversights and dumb mistakes.

Obviously, both Richards and I are a little biased here: we believe the best “someone” is in fact an experienced professional adviser. But it doesn’t have to be. It could be a trusted accountant, a skilled lawyer, a business colleague, a mentor. The point is to have someone who can help protect you from making dumb decisions, whoever that person is for you.

As I stated in my 2001 book, True Wealth: a guide for high-net-worth individuals (and their advisors), “Wealth tends to amplify your personality.” This is as true today as it was then, and I have observed this in my everyday life working with wealthy families.

Thane Stenner is founder of Stenner Investment Partners within Richardson GMP Ltd., as well as Portfolio Manager and Director, Wealth Management. Thane is also Managing Director for TIGER 21 Canada (www.tiger21.com/canada) . He is the bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors)’. (www.stennerinvestmentpartners.com) (Thane.Stenner@RichardsonGMP.com). The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Richardson GMP Limited, Member Canadian Investor Protection Fund.

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