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Given our lengthening lifespans and aspirational lifestyles, almost all of us need to invest regularly if we want to achieve our long-term financial goals, such as financial freedom. But our brains aren’t cut out for it. In fact, they actively get in our way. The same instinctive behaviours that served us well as hunter-gatherers can be disastrous when applied to investing.
The good news is that technology is evolving to solve this problem. Exo Investing uses advanced algorithms, developed over several decades, to handle both the short-term, day-to-day risk management of a portfolio as well as the long-term investment strategy. By removing the human, emotional element from this area of the investment process – which is where it can do the most damage – Exo frees investors up to make the high-level investment decisions. It’s a more efficient way to invest, not to mention a lot less stressful for the investor.
But what is it that makes us so prone to investment errors in the first place? Most of us, from experience, realise that our decision-making process is imperfect. But it wasn’t until the 1970s that behavioural economists began to understand the specific ways in which our behaviour is flawed. Daniel Kahneman – who went on to win a Nobel prize in 2002 – and Amos Tversky, pioneers in the field, were among the first to describe and study these behavioural biases. Here are just three of the better-known ones:
We fear losses more than we value gains (roughly twice as much, in fact). This causes several contradictory investment behaviours. On the one hand, it may lead us to being too risk averse. On the other hand, it means that when an investment goes wrong, we hate the idea of ‘crystallising’ the loss by selling out, even if the fundamentals are deteriorating. As a result, we hang on to losers for too long, and sell winners too early – the opposite of what investors should be doing.
In our constant search for cognitive shortcuts, we often grab hold of the closest piece of information to hand. This then influences our view, even if it’s irrelevant. In an investment context, this often happens when investors spot a share price that has fallen heavily, say from £5 to 50p. The fact that the share price used to be £5 is neither here nor there – there are often very good reasons for such declines, such as losing a big customer. But an investor will often ‘anchor’ to the higher price, and buy in, believing that the share price ‘should’ go back to £5, despite the change in fundamentals.
Thinking takes effort. As a result, once we have made up our mind on something, we prefer not to have to change it again. And so we avoid information that contradicts our world view, and seek out information that confirms it. This makes it very hard for us to change our views on an investment once we have committed to it, even when it is clearly not performing in line with our initial expectations. We would rather stick our heads in the sand than be forced to change our world view.
There are many more such biases – Exo has put together a list of six of the most common here – but in short, these emotional shortcuts can be very damaging to our wealth. And simply being aware of your brain’s tendency to make mistakes while investing, doesn’t make it any easier to resist self-destructive behaviour. This extends to professional fund managers too. Indeed, you can argue that the pressure of managing other people’s money makes them even more prone to certain biases – the herding instinct in particular.
In short, when it comes to investing, you are your own worst enemy – which is why Exo could be your new best friend. Exo’s algorithms won’t leave you anchored to irrelevant information, or running around chasing the next hot fund. Exo simply manages your money in the most effective manner in order to meet your financial goals. Think of Exo as your investment co-pilot – you set the overall course, and Exo does the day-to-day portfolio management, with all decisions driven by data rather than emotion. That way, Exo can prevent you from making many of the classic mistakes, driven by greed or fear – or both – that are most likely to damage your wealth.
Join the behavioural investing revolution – find out more about Exo today. Visit exoinvesting.com
When investing, your capital is at risk. The value of your investments can go down as well as up, so you could get back less than you invested. © Exo Investing is a trading name of Finhub Technologies Ltd. which is authorised and regulated by the Financial Conduct Authority (Financial Services Register number: 748161).