HONTI #6: Distrust the Experts

Rule #6: Don't take experts at face value: check their knowledge and their results.

Trust Needs To Be Earned, Not Assumed

In a complex world we often have no choice but to rely on experts to help guide us. If we’re going to lean on such people, though, we really ought to make sure that they know what they’re talking about. This is certainly true for financial experts, but is equally true in other areas as well: relying on the first medical opinion you get isn’t generally a smart move, either.

It seems there are certain areas in which we actually default to trusting our advisors rather than distrusting them – doctors, teachers, attorneys and so on.  Often this trust is justified, but sometimes it isn't – and when this happens we lose out. It turns out that a default of not trusting our advisors is the safest approach, even if that feels ethically dubious¹. We are, on the whole, inclined to trust people, but mistaking an advisor for a friend is a risky strategy.

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HONTI #5: Home Is Where The Risk Is

Rule #5: Reduce your risk by diversifying your investments internationally.

Familiarity Is A Poor Basis For Investment

Home bias¹ afflicts almost all investors, of all shapes and sizes. It’s the tendency to invest in firms that are close to home in preference to firms that are far away. This is true in both a geographical and a mental sense, and the net effect is that many portfolios are unsafe, under-diversified and unbalanced. A bit like most of us investors, really.

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HONTI #4: Disconfirm, Disconfirm, Disconfirm

Rule #4: Look for evidence that you're wrong, not that you're right.

Be Prepared to Change Your Mind

"When the facts change, I change my mind. What do you do, sir?"; John Maynard Keynes (allegedly: see Quote Investigator)

Once you've done your careful research, or blindfolded a bemused ape and got it to stick a pin in a list of stocks, and bought into some corporation or another, you immediately become exposed to one of the nastiest behavioral biases on the block: confirmation bias. You will, whether you realise it or not, start to favour information that supports your decision and to discount that which doesn't.

Ever get a nice warm feeling when someone tips¹ a stock you own?  That's confirmation bias in action and if you let it blindside you it'll take you down, along with your portfolio.

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HONTI #3: Don’t Fear Volatility

Rule #3: Don’t worry about short-term price trends, turn off the portfolio tracker.

Risk

"The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances"; Ben Graham, The Intelligent Investor

Imagine if you could pick up the paper every morning and riffle through the pages until you get to the property section where, half way down the third column, you could find the current price of your own home. Imagine further that this price was set by a bunch of people you’ve never met making apparently random bets based on a combination of intuition, centralised economic statistics, a bunch of robots programmed by people with the social skills of a twig and, a couple of times a year, the real price achieved by one of your neighbours actually selling.

Welcome to the world of asset price volatility.

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HONTI #2: Hindsight’s Not So Wonderful

Rule #2: Don't forget the past, get yourself some feedback.

Feedback

"Those who cannot remember the past are doomed to repeat it"; George Santayana, The Life of Reason

The second most dangerous trap any investor can fall into is the “I knew it was going to happen” syndrome: the remarkable ability of people to decide that they can predict the future, but only after that future has already happened: an exercise in futility were it not so damaging to investment prospects. This isn’t just a problem for amateur investors either: studies of investment bankers, for instance, show that those bankers least affected get the best returns: and vice versa¹. Overcoming this wilful amnesia is critical to improving investment results.

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HONTI #1: How Not To Invest

Rule #1: Bias the odds in your favor: start by avoiding the avoidable mistakes.

Introduction

There aren’t many good ways to invest, but there are countless bad ones. Yet the knack to successful investment, in the end, is formidably easy: learn how not to invest – and then do the opposite. Perhaps the biggest problem for investors is that the very nature of investment tends to cause automatic behaviours that damage our returns. It’s not hard to find the underlying causes – we evolved to cope with a very different environment, where decisions were a matter of life and death. When these decision making mechanisms are translated into the modern world they cause us to behave in ways that economists regard as irrational, and which are generally damaging to our personal wealth.¹

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