Are More Choices Good For You?

More choice equals more freedom, therefore “Good!” seems like the self-evident answer.  As with all other self-evident answers, this one is wrong. That wrong result has significant impacts on financial advisers and on their clients. Reality is that the more choices you have the more dissatisfied you will be, and the more dissatisfied you are the more changes you will make, and the more changes you make the poorer will be your outcome. And you will make the changes even when the outcomes are good enough, even very good.

Consider my friend Eugene. He is a super-organized master of detail. Many years ago, in July of that year, he paid off the mortgage on his home and as the result had money to invest each month. His investment vehicle of choice was a Registered Retirement Savings Plan, (RRSP) which would give him both savings and a tax advantage. But which one?

Being super organized, he prepared a spreadsheet. (Actually a lot of large paper sheets taped together on the dining-room table with inked columns and rows.) Each column was a possible RRSP plan and each row was a characteristic of that plan. The detail in each box he derived from an almost infinite number of brochures that he acquired from every bank, trust company, credit union, insurance company, stock broker and fraternal organization that he could find.

It was to be a supremely rational decision, but choices impaired rather than helped.

As the end of February deadline approached, he became more frustrated. According to his wife, at one point there were 174 plans in the matrix. What should he do? What did he do?

He made an excellent choice. He took the money he had set aside and they went to Hawaii for two weeks.

Why was that a good choice? Because it did not deal with the RRSP decision.

By having many choices, he guaranteed eventual dissatisfaction. No matter how good his first choice might have been he would have found in a year or two that there was a better one he should have made. Dissatisfaction leads to weak decisions in future. By choosing Hawaii he avoided the choice/dissatisfaction problem.

Eventually he accepted “good enough to get what I want” as a reasonable option.

For advisers, offering many options seems like a good idea. It makes you look impartial. Pick what you like, I can do it. But it does not work. You are the expert, the client is the one who knows the least technically so why should they make the decision.

If a doctor treating you for serious disease #7 said, “There are four choices for treatment. Here are the risks and probable outcomes for each, which do you want?” you would be appalled. You would likely say, “Which do you think is best?” or, “If you were me, which would you choose?” You would not be accepting of, “But I am not you and you need to decide.”

Marketing folks believe that clients value choice, it is a part of their differentiation approach. The evidence, from author and professor Barry Schwartz, is that while clients value choices, they don’t want to make them and when they pick from many they tend to be more dissatisfied with the outcome. That makes for poorer client relations.

When there are fewer choices, people expect less. There is room for a pleasant surprise. Today, with all the choices, people expect too much and are dissatisfied when it does not appear.

How do you manage expectations and performance successfully when perfect is the minimum?

Make recommendations. Accept some responsibility. Do not try to dump the decision risk to the unknowing client. If you are concerned about the liability find another client. One who gets it.

No matter the choice someone makes, it will never be the best one. It does not need to be the best. It merely needs to be good enough to reach the goal.

Decide that “good enough” easily implemented and easily monitored for management and easily monitored for connection to your plan is what gives you freedom.

More choice increases risk because it expands the reasons for dissatisfaction. (With a lot of choice there is an implicit opportunity cost.) When dissatisfied, you change something. Change hurts outcomes because change costs and so you cannot afford to do it very often. By having more choices, your risk of loss increases even if all the choices are good ones.

When you think about it, how badly served would you be if you put all your money into a balanced portfolio with a manager who had a decent record. They study the market and select investments. They reallocate to keep the predetermined ratios. You do little other than check to see if they are still investing as you expected them to do and supply the capital.

I have never checked to see if an average, or a little above, balanced fund is the answer but my instinct is that over a long time, I would be ahead both money and satisfaction.

The best satisfier is getting what you want.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Shortcuts to Ruin

Shortcuts to Ruin

“Buy low, sell high” is likely the most widely quoted financial market truth of all time. It makes so much sense, yet it is one of the most difficult tasks to repeat successfully in financial markets. The fundamental assumption of your investment decision making is grounded in the belief that you will rationally make a choice that leads to the highest possible financial gain.

But is this assumption always correct?

In order to speed up our decision making all humans utilize shortcuts or rules of thumb, which we use to draw inferences and make decisions from the information we receive. These shortcuts are called heuristics. In many circumstances, these shortcuts are close to being correct, but they also frequently result in some decisions being repetitively wrong. The result is that we are all susceptible to particular types of decision making errors because of our heuristic biases.

The most common heuristic biases are described below. Can you see how these biases may have affected your past investment decisions?

 
Availability Bias – “Trade the News”

You will predict the frequency of an event, based on how easily the occurrence of a previous similar event can be remembered. If you can remember it quickly, then you believe that it must be important. Therefore, recent events tend to have a greater impact on your decisions than past events and, consequently, recent news is viewed as more important than previous news.

Most individual investors rely on some type of media reports for a large amount of the information they receive regarding financial markets and investments. The financial media tends to report some types of information frequently because they view it as newsworthy. You will often view more frequently reported information as important and allow it to influence your investment decision making, rather than objectively weighing its relevance.

Representativeness Bias – “I Will Wait For a Correction to Buy”

You will regularly make judgments by relying on stereotypes. While this process may be correct in some circumstances, it can be very misleading in others.

Imagine that you purchase a stock and then watch its price increase for 10 consecutive trading days. What should you do: sell or hold?

You may believe that you should sell the stock since it cannot possibly rise in price for an 11th consecutive day. Or can it?

Imagine that you purchase a stock and then watch its price decline for 10 consecutive trading days. What should you do: sell or hold?

You may believe that you should continue to hold the stock; since it has fallen for so many days in a row any further decline is unlikely. Or is it?

In both these regularly occurring financial market scenarios, representativeness bias is present and has an influence on your investment decision making process. The fact that a stock has advanced or declined in any previous trading session does not have any bearing on whether it is more likely to reverse direction during the next trading session. Although you should know that this fact is correct, you struggle to overcome the influence of the past on your decisions about tomorrow.

Hindsight Bias – “I Knew It Would Double!”

You are inclined to see events that have already occurred as being more predictable than they actually were before they took place. You also tend to remember your predictions of future events as having been more accurate than they were, especially in the cases where those predictions turn out to be correct. Once you learn what occurred, you look back and believe that you knew all along that the result was going to happen. This encourages you to view financial markets as being more predictable than they actually are.

Hindsight bias develops as you detect new information. Your brain immediately processes the information by incorporating it into what you already understand. This revised understanding then becomes the benchmark from which future information will be evaluated. This process limits your ability to go back in time to objectively assess your state of knowledge at the precise moment that a past event occurred.

Overconfidence Bias – “I Always Make Money”

You tend to hold an overly favourable view of your own abilities. As a result, you are overconfident in the reliability of your own judgments to a much greater degree than should be expected based on facts alone. For this reason, you tend to be surprised by an outcome more frequently than you would anticipate.

We all tend to think that we are better than our peers. In survey responses individuals consistently rate themselves as being above average when they are asked to compare their abilities to a group. Being overconfident is not necessarily a bad personality trait, as it can boost your self-esteem and give you courage to try new things. However, the drawback is that it also leads to overestimating your chances of success or underestimating risks. It leads you to believe that you can control or influence outcomes, when in reality you cannot.

Overconfidence bias causes you to become too assured about your own judgments and not adequately consider the opinions of others. This false belief in your superior judgment is also linked to a perception that your investment decisions will be less volatile and risky than may actually be the case.