The founding fathers of behavioural finance hail from two disciplines – psychology and economics. The biggest name from the former group is arguably the Nobel laureate Daniel Kahneman, who has often featured here on The Value Perspective, while a leading light among the latter is Richard Thaler, who has not. The recent publication of his latest book affords us the chance to put that right.
One passage from Misbehaving: The Making of Behavioural Economics that particularly caught our eye argues that the way financial data is presented can have an impact on people’s investment choices. Thaler refers to an experiment he ran in the US where half the subjects were shown a range of possible returns – some positive, some negative – that equities might generate over the course of a typical individual year.
The other half of the subjects were shown the average annual returns the asset class might produce over three decades built up from the annual returns shown to the first group. Over this longer timeframe one would generally expect a decent showing from equities overall as individual bad years are very likely to be offset by better ones.
Even though the two sets of figures came from exactly the same set of underlying data, those people who saw the data showing that stocks could deliver annual returns as low as –40% allocated a far lower portion of their pot to equities than those shown the 30-year averages where even the lowest average annual return was more like +1%.
The implication seemed to be that, if people were shown the average levels of returns equities can generate over the longer term – which tend to be consistently positive – they would be much more aggressive in their asset allocation than otherwise. So Thaler, Kahneman and another leading behavioural psychologist, Amos Tversky, ran a second experiment where they showed the results of an investment simulation to different groups of subjects.
One group were shown the results of the simulation as if they were checking their portfolio eight times a year, a second group as if they were checking it once a year and a third as if they were only doing so once every five years. Once again, the people who were shown the numbers at lengthier intervals – and so saw less volatility in the results – allocated much more aggressively to equities than those who saw them more frequently.
About the same time, there was an odd instance of life imitating academia. A leading pension fund in Israel, where both Kahneman and Tversky were born, changed the front page of its reports so that they showed fund performance data for the12 months prior to publication rather than just the previous month. As a result, the weight of equities in the average scheme edged upwards as investors worried less about volatility.
Many investors may well have found it hard to look away from the ‘car crash’ of global markets in recent weeks. Here on The Value Perspective, however, we would urge anyone who owns equities with the genuine aim of an inflation-beating total return over the long term – in our biased view, these are the only reasons for owning equities – and who wants to get the best out of these holdings to keep their discipline and only check on their portfolio when they really need to.