A Little Knowledge Can Be A Dangerous Thing

To manage our money better, often we don’t need to know more. Instead, we need to unlearn what we think we already know.

Here are just some of the things that, at various points in our life we may have thought we knew (but historical evidence clearly shows we don’t):

• Which asset classes will outperform in the short and medium term
• Which way the economy is headed
• What’s next for the direction of interest rates and share prices
• Whether the world’s share-markets are overvalued or not at any point in time
• Which share and property market sectors will fare best
• Which individual shares will beat the market

A waste of time and energy

Why do we think we know such things? It’s partly because financial institutions with vested interests and the financial media talk endlessly about these issues. The financial media needs to fill airtime, websites and printed pages. Meanwhile, many investment houses want to convince you that they can help you know something about the future, so you actively manage your portfolio and thereby fatten their coffers.

But not all the blame belongs to others. Our belief that we have knowledge also partly stems from the way we’re wired. That wiring leaves us vulnerable to a host of behavioural mistakes, including extrapolation, overconfidence, loss aversion and recency bias, which together conspire to convince us that we know what the future will bring.

The temptation to act

The problem is, when we think we know something, we’re inclined to act upon that knowledge. In the financial markets, action almost always triggers investment costs and perhaps brings forward some big tax bills. If we mess with our basic mix of shares and conservative investments, we may miss a big market move — and any time we opt to reduce our overall growth asset exposure, we also lower our portfolio’s expected long-run return. And if our purported knowledge causes us to make narrow investment bets, we risk a permanent loss of capital, as we bet on shares and market sectors that could potentially plunge — and never bounce back.

Even if we put our hands on our heart and we swear we aren’t inclined to forecast, predictions often creep into our behaviour. We hold off investing because we sense share prices could fall. We tilt toward particular Australian shares because we think that they’ll always outperform foreign markets. Instead of prudently diversifying, we hang on to loss-making shares because we want to get our money back and we believe the share price doesn’t fully reflect its value.

Focus on things you can control

What if we thought harder about such issues?

No matter how much we analyse individual shares or other assets, different market sectors and the overall market, there is no empirical evidence we’ll come up with a better forecast. Instead, our best bet is to not forecast. We need to unknow these things that we think we know, and instead focus on facets of investing where we have some control and where we truly can add value. We’re talking here about our overall wealth strategy the amount of portfolio risk we take, the investment costs we incur, the taxes we pay and most importantly, managing our own investor behaviour.

There are also other areas of our financial life where hard work and more thought can pay handsome dividends. We can substantially improve our financial life by figuring out which debts to pay off first, how much do we need to save, what sort of home it makes most sense to buy, what are the best tax structures for our investments, what insurance we need and what estate planning steps we ought to take.

The reality is that most people are searching for a level of certainty in this uncertain world – and when it comes to your financial strategy, this is where a good adviser can add significant value – by avoiding the urge to crystal ball gaze and by partnering with you to focus on elements within your control to build a reliable, sustainable plan for the future.

The future will always be uncertain but a relationship with a good adviser can give the client the comfort he or she needs to get on with life, without undue worry.

To be sure, none of this has the seductive pleasure of making forecasts and imagining we’ll be proven right. But over a lifetime of investing, that pleasure, alas, almost always carries a steep price tag — and that’s one thing we all need to know.

Next steps

To find out more about how any of these measures may be of assistance in your individual circumstances, please contact Gordon Thoms or David Conte at Calibre Private Wealth Advisers on ph. (03) 9824 2777 or email us here.