Overcoming your irrational inner self

"It's not only Lotto players who are deluding themselves". Picture: Jim Rice
"It's not only Lotto players who are deluding themselves". Picture: Jim Rice

WHEN you buy a Lotto ticket, do you choose your own numbers? That's why you don't win.

All right, having the odds stacked against you doesn't help, but there's no advantage over accepting random numbers. Sorry, you're just as likely to lose with either method.

It's not only Lotto players who are deluding themselves. A flaw well known to behavioural scientists when it comes to investing is what the QUT Business School calls the "illusion of control". Its partner-in-crime is "overconfidence bias".

By which it means we think we're in control when we're not. Does that remind you of something? No, I meant the sharemarket. If you think you're in control you'll underestimate the risks, a mistake made worse by tending to plunge into a single stock instead of diversifying.

That we are our own worst enemies when it comes to investing brings to mind a talk to Morningstar's annual super strategy day by Kerr Neilson, the billionaire fund manager who founded Platinum and is the closest we have to the legendary investor Warren Buffett.

For him price is everything. He remembers how "time and again I'd hear you could rely on companies supplying food because people have to eat. Yes, but at what price?" I did say he's a fund manager.

But you can see his point. When buying a car, the first thing you ask is what it will cost. Same for shares: pay over the top as an investment and you're buying a crock, no matter how good the company is.

Fortunately he has some tips, again correcting our irrational inner selves, about finding the right price.

A big boo-boo is "chasing yesterday's story". By the time you hop on the bandwagon it's too late because "invariably there is not a lot more prospect to make money out of". The stocks nobody wants are where you'll find any gems.

Anything out of favour is always oversold.

"Any grandiose problems the market has already adjusted for. It's no longer time to fret about it."

Neilson has also published a little booklet called Curious Investor Behaviour. I warn you, it gets personal. But tell you what, a mass mailout of that would do more to reduce our reliance on the pension than poor old Dr Karl spruiking the government's Inter-Generational Report.

Experiments have proved that the pain of a loss is felt twice as strongly as the pleasure of a profit - the source of many irrational biases.

Don't believe it? Then compare how hard you'd kick yourself for misplacing $100 with your more constrained relief at finding it again.

And so we cling to losses on an investment hoping it'll bounce back one day. Even in that unlikely event, having probably paid too much for it initially, think what the money could have been doing somewhere better.

Mind you, selling winning investments too early is probably as common a mistake, though at least that's money not lost - just not made. Another foible is taking on board information that confirms a belief and subconsciously downplaying that which undermines it - all elements of self-deception, I'm afraid.

These are the more controllable irrational biases. It's the subtle ones that can trap you.

One is what psychologists call "framing", which is not seeing the whole picture because of how it's presented. For example, how a question is framed can mean taking something at face value without realising it.

In a 1984 study, physicians were asked to choose between two programs proposed for handling an epidemic that was expected to kill 600. Option A would save 200. Option B would mean two-thirds die.

Which would you choose? Oh dear, glad I'm not your patient. But then I'm not sure about those physicians either, since 72 per cent chose Option A.

How come? Because it was a trick question - they were supposed to see that both had the same answer (two-thirds dying from 600 is 400, leaving 200 saved).

Framing is a salesman's modus operandi at property seminars and the like. Even if the descriptions and figures that are presented are true, it's the ones that aren't which you should worry about.


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