The Biggest Risk to Your Portfolio

The biggest risk to your portfolio isn't the markets.

It's the wiring in your own brain.

First, why is our brain wired this way?

Evolution has made any behaviour that helps us survive or reproduce feel pleasurable and rewarding.

Any behaviour that is bad for us feels painful or punishing.

Today’s “modern” human brain appeared about 150,000-200,000 years ago.

For most of that time our ancestors lived in primitive hunter-gather societies.

Humans have spent more than 99% of their evolutionary history in the hunter gatherer environment.

What behavior has been natural for 99% of human existence?

A tendency for fear.

Fear is our most basic emotion. Fear has evolved to help us anticipate danger and avoid pain.

Our ancestors’ environment was fraught with dangers. Fear of physical danger, lack of food, predators, etc.

Consider two individuals who heard a strange sound behind the bushes. One of them looked behind the bushes, was bitten by a poisonous snake and died.

The other one saw what happened, ran away and survived.

The cost of being wrong and running when there was no snake was minimal. But the cost of being wrong and running when there was no snake was minimal.

Behavior like this helped our ancestors survived. But it’s programmed us to be terrible investors.

Reward & punishment

After a success, we become overly optimistic risk-takers.

After a failure, we become overly pessimistic and risk-averse.

Even in cases where success was a result of chance.

A good result doesn’t necessarily mean a good decision was made, and the same goes for bad results.

Confirmation bias

Once we’ve made a commitment, we want to remain consistent.

We want to feel like we’ve made the right decision.

Think about buying a stock. You want to be proven right.

Or it could be a belief you have about investing.

You will actively seek out information that supports your decision.

You will ignore or discount any other information.

Actively seek out information that disputes what you think. There’s usually two sides to every argument and make sure you understand both sides.

And remember that one of the smartest things a person can do is admit that they were wrong.

Anchoring

We get over-influenced by information that serves as an anchor.

People will hold a losing stock forever, in the hopes that it will one day recover to the price that they paid for it.

“I bought this stock for $30, and I’ll sell it once it gets back to that price”

Realize that the price you paid for something is now irrelevant. That’s old news. What’s it actually worth today? What’s the opportunity cost of holding on to a loser instead of investing in a more productive asset?

Do-something syndrome

We sometimes act because we can’t sit still. It feels boring. And in many parts of life, results require action. If you want to get in better shape, you need to work out more.

But investing is one of the few areas of life where action is generally counter-productive (if you have a good strategy to start with).

If you have a well-thought-out portfolio, stick with it. Don’t confuse activity with productivity.

Authority

Names and reputations influence us. We listen to people on the internet, TV, newspapers etc. for investment advice.

We listen to investment analysts making yearly predictions about what the stock market will do.

Instead of blindly following authority figures, ask yourself, “What is their track record for success?”

“Are they actually qualified and trained to provide this advice?”

Stress

The more stress we experience, the more we tend to make decisions that are short-term.

This is why some of the worst investment decisions are made during volatile times in the stock market.

You can’t change what happens in the markets, but you can influence your environment.

Are you tracking your portfolio on a daily basis?

(There’s a reason people who do this have worse performance than people who check less frequently.)

Is your portfolio suitable for your risk tolerance?

Recency bias

We give more weight to information or events that are fresh in your mind.

It’s why people overreact to market downturns, even though they happen all the time.

It’s why people get excited and buy investments based on recent performance.

Zoom out when making decisions. Is this something temporary? Am I chasing performance? What does the long-term evidence say?

Impatience

Jeff Bezos once asked Warren Buffett, “Your investment thesis is so simple. Why doesn’t anyone copy you?”

Buffett responded, “Because no one wants to get rich slowly.”

It’s true. Getting rich through investing is pretty simple. Have a good savings rate and invest in boring, diversified investments. The only downside is it doesn’t happen overnight.

It’s why people fall for the get-rich-quick schemes. Think crypto, risky stocks, and trendy real estate investments promising 20% annual returns.

Getting rich slowly isn’t exciting. But it’s the only approach that consistently works.

You don’t need to eliminate these biases.

Everyone has them.

The goal is to recognize them.

And put systems in place so they don’t make decisions for you.