SUMMARY

• Behavioural biases cause the average human to make sub-optimal investment decisions
• Market timing should not be attempted
• Simple and robust risk management systems may help overcome some of our issues

INTRODUCTION

Investing and driving have some similarities. When driving a car, the driver gets to the destination most of the time without serious issues. There are however, like in financial markets, infrequent car crashes, which may result in substantial personal harm and costs. In most developed markets car drivers are legally obliged to purchase insurance, which will provide protection in the case of an accident. In financial markets most participants “drive” without or limited insurance and just blindly hope that there won’t be an accident at some point, despite clear evidence of previous accidents in the rear mirror, or believe they can somehow avoid them.

MARKET TIMING

Naturally we don’t believe that investors should be encouraged to pursue market timing as there are decades of empirical evidence that investors are not particular good at that. The constant struggle between greed and fear combined with a number of behavioural biases are working against us. Trying to time the market is the incorrect approach as we usually sell when we should not, e.g. in October 2008, and are out of the market when we should be invested, e.g. March 2009. The Dalbar studies highlight the dramatic underperformance of retail investors trying to time the market:

Investor vs Market Returns PA