Good investors make decisions they hope will cost them money

He observed that:

• If we make a decision when the odds and evidence are heavily in our favour, and it doesn’t work out, that doesn’t (necessarily)make it a poor decision.
• A prudent investment approach means making certain decisions that we expect and hope to disappoint.
• Diversifying across a range of assets or securities is an acceptance that we cannot predict the future and that we will be wrong about many things.
• Appropriate diversification means always holding some assets and securities that appear to be laggards. This is the intended result.
• Instead of making binary investment choices, where the outcome may be a complete success or an abject failure, we know that it is prudent to make choices where we hope and expect some of our bets to be wrong, so that no matter what transpires in the future, we end up with a better outcome.

Let’s make a bet
Invest R1 million for five years. You only have two choices: Fund A which tracks the MSCI World Index of the biggest companies in the world (such as Apple, Microsoft, Amazon, Facebook, Alphabet (Google), Johnson & Johnson, Tesla, Visa, Nestle etc) and Fund B which tracks the US Dollar price of gold.

You have to allocate your R1 million between the two funds. What do you do?

Many of us will have a view of which fund we believe will outperform over this period. Some of these views will be more “confident” than others. If you believe, for example, that Fund B will “definitely” outperform Fund A, would you put your entire investment into Fund B, or would you allocate a significant percentage to Fund B, but still allocate some to Fund A in case you are wrong? So even though you are “certain” that Fund B will outperform Fund A – and you hope that it outperforms – you will still allocate capital to Fund A – and hope that it underperforms.

This decision, whilst uncomfortable, is both sensible and prudent
After the event, diversification only feels gratifying if our convictions were wrong. If we were right, it feels like a cost.

“Sensible investment is not about predicting a single path and trying to maximize your returns if it comes to pass.  It is about ensuring that you are appropriately positioned for a reasonable range of outcomes.  By all means have a view, but it needs to be heavily tempered with an acknowledgement that the future is inherently unpredictable.”

We base our investment recommendations on the information which we have available at any given point in time and recommend that our clients consider that their investment portfolios are appropriately positioned for a reasonable range of outcomes.

Diversification means always saying sorry about something
In hindsight, when we look at the outcomes of investment choices we evaluate whether the information on which the choices were made and the strategy which was followed was the right one at the time – even if at that stage the outcome may not be the optimal outcome which could have occurred.

A prudent, well-diversified investment portfolio which is positioned to be robust in a reasonable range of outcomes delivered by an uncertain future should, and must, contain holdings which disappoint.

To read the full article over at Behaviouralinvestment.com, please click here