Be aware of your impulses – especially in volatile markets
We’re hardwired to speculate, but it may not be the best investment strategy. Here’s how to make good decisions, even as markets move rapidly.
- Especially during times of uncertainty, humans are hardwired to speculate. Our brains are designed to test out ideas and either confirm that we’re right or understand that we’re wrong, so we can adjust our thinking.
- To battle the speculative impulses that can jeopardize your investing plans, seek out information that disproves your ideas.
- Make the best use of expert advice, and don’t try to time the markets.
Many humans love to speculate on just about anything—regardless of their knowledge level. I was reflecting on this fact recently as I browsed the newsstands at a local airport. Magazines and newspapers speculated on the future of the Coronavirus: How many more people would become infected? What impact will the virus have on the short and long term economic outlook? And let’s not forget about the elections. Or the recent Fed rate cut. Given the uncertainty surrounding these topics – and its potential impact on human behavior on many different dimensions – it was interesting to see how inconsistent the views were across publications. As a financial professional, I found myself concerned that the short-term ideas in the news stories may cause people to act in a way that is inconsistent with their true financial and investment goals.
Why do we like to speculate so much anyway? Speculation is a form of hypothesis testing, and humans are natural hypothesis testers. We like to make predictions so that we can see if we truly understand our environment as well as we think we do. If we are wrong, it allows us to revise our beliefs and adapt. If we’re right, it allows us to feel confident that the understanding we have will lead us to productive future outcomes.1 Our impulse to speculate may come from a constructive place: In many cases, it can actually be a form of learning.
However, if we speculate with our investments, we have to live with the outcomes in a very real way. A newspaper stand will not experience a direct impact to its personal and financial goals the way we as humans will. After all, short-term trade ideas are not one-size-fits-all, and a newsstand publication doesn’t know our preferences, goals, or ability to withstand certain risks based on our unique financial circumstances. Before acting on a short-term trade idea, make sure you’ve done the necessary research and that the investment aligns with what you are truly trying to accomplish with your money.
Here are three tips to avoid being drawn into a speculative mindset, especially in challenging global political and market environments.
1. Seek out evidence that contradicts your viewpoint.
Research tells us that people like to find confirming evidence for their ideas. However, it’s disconfirming evidence—or information that opposes your perspective—that may lead to better decision making. Challenging your ideas helps you acknowledge what you truly know—and what you don’t—before you act.2
2. Make the best use of expert advice.
Research that I conducted with my academic advisor, Craig McKenzie, showed that experts and novices were equally overconfident in their decision making. Experts did have one advantage, though: The wrong answers they gave were closer to the truth. Gather a mix of expert advice and think critically about what you learn.3
3. Draw on the power of time in the markets and avoid market timing.
The term “market speculation” is often used synonymously with short-term market timing—a very difficult exercise, even for investment professionals. Instead, identify your investment time horizon (how long you want to be invested for) and whether or not you have the need and ability to take risk. Make sure that any investing ideas you’re considering line up with your time horizon and capacity for risk. And if they don’t, think hard about how to get your investment portfolio to where you want it to be.
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1 McKenzie. Hypothesis testing and evaluation. http://psy2.ucsd.edu/~mckenzie/McKenzieHTest.pdf
2 Nickerson. Confirmation bias: A ubiquitous phenomenon in many guises. http://psy2.ucsd.edu/~mckenzie/nickersonConfirmationBias.pdf
3 McKenzie, Liersch and Yaniv. Overconfidence in expert interval estimates: What does expertise buy you? http://pages.ucsd.edu/~mckenzie/McKenzieetal2008OBHDP.pdf