By Steve Lowrie, Lowrie Financial
Special to the Financial Independence Hub
You probably first heard this classic joke years ago. Maybe you even laughed at it once or twice:
Patient: “Doctor, doctor, it hurts when I do this.”
Doctor: “Then stop doing it.”
Yes, it’s silly … and yet wise. We’ve all been known to ignore what is painfully obvious, especially as investors.
For example, even though we know it’s a mistake to buy high and sell low, there’s ample evidence that this is exactly what most of us end up doing anyway. In “How Investors Leave Billions on the Table,” Wall Street Journal columnist Jason Zweig shared a litany of analyses on how investors lose available returns through hyperactive trading. Zweig published his post in 2013, but human nature hasn’t changed, so the stats undoubtedly remain relevant: We’re hard-wired to trade at all the wrong times.
Why we make mistakes
Let’s talk about how you can stop making this mistake. In researching this question, I came across Joseph Hallinan’s classic book, “Why We Make Mistakes.”
A key point made in Hallinan’s book is to beware of reacting to anecdotes, or single observations. At the opposite end of the scale is the body of evidence formed by countless anecdotes, allowing us to reach more enduring conclusions. As we described in our post, “The risks of reacting to recent news,” anecdotes are to evidence what today’s weather report is to the climate. You don’t want to confuse one for the other.
So, one powerful way to lower the number of mistakes you make is to disregard anecdotes, hearsay and hot news when making investment decisions. If the anecdote is truly important, it will end up being integrated into the durable evidence that guides us to less painful investing.
Steer clear of “Junk Science”
A second, related tip is: how to steer clear of “junk science.”
In the first part of this blog, we talked about how important it is to avoid reacting to rapidly breaking news and other isolated anecdotes – at least when it comes to your investment activities. In addition, I’d also suggest you avoid making trading decisions based on insufficient or inferior evidence or data. There’s a name for that: I call it junk finance or junk financial research, and it may contribute as much or more to those “obvious” investment mistakes we tend to make.
In a “Junk Science Week” series published a while back by The Financial Post, I was struck by these relevant comments from a column entitled Hope Mongering:
Our standard definition is that junk science occurs when scientific facts are distorted, risk is exaggerated and the science adapted and warped by politics and ideology to serve another agenda. That definition needs to be refined. It was shaped by the idea that junk science is strictly the bailiwick of scaremongers. … But science can also be warped to promote the opposite of fear.
The world of investments is riddled with products, strategies and advice that, at their best, are hope-mongering and at their worst bring pain to your financial health. What marks them as suspect is the absence of peer-reviewed academic research to substantiate that they actually work – over time, across distances and through varied market conditions.
Using solid, evidence-based investing helps you minimize those “obvious” investment mistakes, as described in this Dimensional Fund Advisors’ video called “Applying Science to Investing.”
As we’ve covered in this post and our last one, being swayed by junk finance, hope – and fear-mongering, and today’s hot news is more likely to hurt you than to help you achieve your desired financial goals.
If something hurts, there’s no need to wait for your doctor or financial adviser to tell you to stop doing it.
Steve Lowrie holds the CFA designation and has over 20 years of experience dealing with individual investors. Before creating Lowrie Financial in 2009, he worked at various Bay Street brokerage firms both as an advisor and in management. “I help investors ignore the Wall and Bay Street hype and hysteria, and focus on what’s best for themselves.”