Short Term Thinking

The way information is presented to you changes how you feel about it.

Everyone in finance loves a bar chart. In fact, bar charts are the missionary-position of the financial world. Plain, simple, gets the job done.

Of course, you get your financial kinksters – they like to get into scatter charts, candle charts, radar charts, and they LOVE a bubble chart.

The trouble is – if statistics lie, charts are worse. Anyone who has spent quality time in a sadomasochistic relationship with an excel spreadsheet can tell you that.

I’ve been reading a book by funny behavioural guru Richard Thaler:  Misbehaving. It’s a warm and witty guide to how people –  all people – have quirky biases which shape their behaviour (at this point, it's worth pointing out that "Misbehaving" would also tell you all about pricing mishaps and is well worth a read). 

You? You’re super smart so let’s do a quick test inspired by the book: you’re investing your money for the next 30 years. Pick which 2 of these 4 fund managers you would invest in:

 

Happy? Sure? Did you pick the purple and blue (charts 1 and 4) or the red and the green (charts 2 and 3).

What if I told you that 1&4 were the same fund, as are 2&3. All I’ve done in re-order the returns from worst year to best year.

Did you pick the low return for safety? Or the high return?

If you picked both, depending on how the data was presented, there's no shame in that - admittedly, you're easy to fool, but so were the investment professionals I tried it on this week. 

Yup.

This is what the returns look like over 30 years, the cumulative performance:

As Thaler says about his own study:

An implication of this analysis is that the more often people look at their portfolios, the less willing they will be to take on risk, because if you look more often, you will see more losses.
— Richard Thaler

If I just told you to give me $10,000 and shut your eyes for 30 years- not to even glance at your investment and then showed you this – which would you pick?

So over 30 years, US Equities have returned 1746% and Bonds – 605%.

Terrible with percentages? ME TOO.

Let’s say your American uncle left you with $10,000 in 1985, and you put it all in US Equities. You'd have celebrated New Year’s Eve 2014 with $174,000.  But your stupid cousin with the dodgy haircut put theirs in US bonds – they’d have only $60,500.

What about the same chart, with the visible volatility removed?:

All of a sudden it really looks like a no-brainer. You want the one with the higher returns. Unless your masochism runs deeper than excel spreadsheets.

This is the problem all of us face in saving for retirement. That we outlive our money by not taking enough risk. We worry about short-term stockmarket blips. We don’t understand the data that’s put in front of us.

What if I asked you where you thought the UK would be in 30 years? Do you think we’ll produce more goods than China? Grow our population more than India? Find a live, but wet, dinosaur in Lochness?

NO, NO and I hope so.

Embrace the fact that the UK is a tiny island which cannot grow at the same rate as countries like China and India and then ask yourself again:

If I had a time machine and invested your money today and whizzed you forward 30 years to pick up the cash, which countries would you pick?