“We are hardwired to be bad investors,” according to George Cliff, director of research at Clever Adviser Technology.
Speaking at The Verve Group’s Evolution 2024 conference, Cliff explored some of the more damaging behaviours within the investment decision-making process, their drivers and methods for effectively controlling them.
Cliff said behaviour drove “absolutely everything” and that there was a scientific answer to these human behaviours and drivers.
He said: “The two most influential integral behaviours that really drive all investor behaviour are very simple to understand.
“What I will start with is the secret to investment success. Run the winners, cut the losers. You will have heard this age-old philosophy proven time and time again by many of the most successful investors in modern history to be a very effective way to build portfolios, outperform markets, and deliver top tier returns.”
Cliff claimed the science consistently showed when it came to money, people tend to make decisions that are counterintuitive and oftentimes detrimental.
He said: “There are some clear and very simple to understand rules to being successful in the financial services space and investment markets. But people let their emotions run free, and they overrule the evidence.
“Think of the economic growth we could experience if people were only rational? And I'll be honest, it plagues me. Why is it that we struggle to do that? And it's because of these things, plain and simple, we are hardwired to be bad investors. That is the long and short of it."
Cliff explained there was a part of the brain called the amygdala where survival instincts, fight or flight are assessed.
“We also process money decisions here. We look at money in the same way we do mortality. And it's because of that that when we start to lose money, we fear, adrenaline kicks in and we make impulse decisions, knee jerk decisions. Like selling winners early,” he added.
Disposition effect
Cliff also described the 'disposition effect', a theory that people have the disposition to sell winners too early and ride losers too long.
“The reason we do this is because as a species we are fond of balance, of symmetry, and what we tend to do is sell our winners early to offset the losses we might be seeing in other areas of the portfolio,” he said.
Cliff claimed as humans, we generally reframe bad behaviours and not refrain from it.
“We hold on to those poor performers, and that is all because of loss aversion. We don't want to realise the loss because we feel the pain. We'd much rather spend five years in a fund that’s not performing great until the cycle brings it back instead of just binning it off,” he added.
Active vs Passive
Cliff explained how human behaviours that drive people to make counterintuitive decisions have a lot to say for the active/passive debate and the misconceptions around active performance.
