Why do people sometimes make bad decisions? Even smart, open-minded, thoughtful people can and do make poor choices. But why? This article is inspired by a conversation between two of my favorite thinkers, Shane Parish of Farnam Street and Adam Robinson, founder of the Princeton Review. Their research identifies situations where we are prone to mistakes and poor judgment — specific circumstances where we should just not make any important decisions. Here are the fundamental sources of mistakes, often inevitable, and probably a feature of life in general.
Have you ever been lost while driving and unconsciously reached down to turn off the radio to help yourself think? This is your subconscious stepping in to control the sensory overload of your environment to create more space to think. Information overload is common in investing where opinions, data and models are in infinite supply.
Examples of information overload in investing include: Leaving CNBC on the TV or a browser while you work, habitually refreshing Twitter or Bloomberg.com for more information, considering portfolio changes with kids running around in the background, or watching football while reviewing your investments. Overload distracts you from the information that matters most. Of course this is easily solved by controlling your environment, setting aside finances until quieter moments and by delegating responsibilities to firms like Osbon Capital.
Being outside your circle of competence
Real estate investors tend to stick to real estate. Restaurant entrepreneurs tend to open more restaurants. Tech founders are more confident than most when buying into an emerging tech stock or a crypto currency. Stepping outside of your circle of competence to evaluate an unfamiliar investment product exposes you to unknown risks in unfamiliar territory. The allure of extreme returns can draw people out of their circle of competence and into the unknown. For instance, the biotech field can deliver exceptionally high returns for a breakthrough treatment, but few investors have the decades of education and insight to effectively evaluate an opportunity.
Being outside your normal environment or changing routines
Changing offices, moving homes, working on the road are obvious examples. A less obvious example is a change to an online user interface. All of the sudden you log in to find that the buy/sell/transact interface for your brokerage is completely redesigned. Or your favorite financial news website has flipped upside down and you have to spend extra energy to separate the ads from the content. The unfamiliar look can distract you from key information.
Physical or emotional stress, illness or fatigue
An overly busy, unsettled, fatigued or upset mind opens the door to poor decisions. It’s common today to work too hard and sacrifice self-care; unfortunately it eventually leads to mistakes, no matter how perfect your track record. Don’t use your sick day to re-evaluate an investment or review a portfolio. Our work warrior culture often pushes us up to and beyond this point.
Rushing or urgency
Hurrying causes mistakes. There are many well-known examples of famous musicians leaving multi million dollar instruments in cabs or on trains while headed to performances. Rushing to buy or sell during a period when you are short on time, and trying to squeeze it all in, will eventually lead to an error. As Adam says, “If you are outside your normal environment and you are rushing, you are in big trouble.”
Fixating on an outcome
When you are fixated only on making money, you’re open to one of the most common investment mistakes: buying high and selling low. Stocks that have doubled or tripled in recent years can look like sure winners. But past performance is not predictive. If your only goal is to make money, you may find yourself selling at the first sign of trouble — often at a loss. Focus more on an investment’s long-term return potential, however you may evaluate that quality, and less on the specific outcome of “making money.” Good investments can lose money in the short-term.
Being in the presence of a group
Group think, social pressure and echo chambers are real. It’s in our nature to agree with the group (our group) without even realizing it. Many famous investors credit their success to their isolation from the echoing chatter of Wall Street, Main Street or Silicon Valley. Beware of getting sucked into the potential group think of your local country club, social circle or work team.
It all adds up
Keep in mind these factors are additive, meaning they can be combined on top of each other to significantly increase the risk of a mistake. The big takeaway is that it’s very easy to make mistakes when you’re not paying attention to your environment, mood or mindset. We can help with this problem. People hire us to isolate their investment activities within our circle of competence and away from distractions or diffusions of attention. We’ve made it our job to maintain a consistent, distraction-free environment that minimizes the risks above. Since it’s our full-time role to manage family wealth, we design our process to optimize for a clean and clear path of execution.
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