Decisions, Decisions
Hello folks, a quick word from me before we get into it.
There are now 560 odd folks who receive these emails every week - which is pretty cool.
However, if your inbox is anything like mine you will be bombarded by emails on a daily basis and this can become pretty tedious. As such, if you would prefer not to receive “The Money Den” each week you can find the button to “unsubscribe” at the foot of this email.
I’d hate to lose you of course, but I think it is only fair to point this out periodically as this button can be a little hard to find if you don’t know where to look.
Nice one.
Let’s, for a moment, imagine two hypothetical investors - Bill and Bob.
Bill invests into a concentrated portfolio of twenty individual stocks. His “best ideas”.
Bob instead invests in a single fund which captures the entirety of the stock market.
One morning, Bill wakes up to the news that one of the companies in his portfolio has announced a “profit warning”1. The stock is down 30% at the market open in the blink of an eye.
When he finds this out, Bill has a number of really quite important questions to ask himself:
Is this a temporary problem, or is the underlying business now permanently impaired?
Given this news has come “out of the blue” does he still believe in the management of this company?
How well have management explained the reasons for the miss?
Is this problem specific to this individual company, or is it part of a sector wide slowdown?
If it is a sector wide slowdown, are these problems confined to this particular sector or a result of a slowdown in the wider economy?
Has the market properly discounted this new news, or has it over or under-reacted?
How can he be sure of this?
Is this the last of the bad news, or could there be more to come?
Is Bill’s original rationale for investing in the company still in place, or does this warning change things?
Does he sell the stock?
Does he buy more?
If he sells the stock, what are the tax consequences - if any?
If he sells the stock, does he reinvest the money?
If so, what does he buy?
What costs and charges are involved in placing these trades?
That is quite a lot to have to digest over your morning latte.
Bob, by contrast, doesn’t even notice this has happened. The only decision he needs to make is whether to buy a regular croissant or an almond croissant.2
In 2011, a flagship study of over 1,100 parole hearings in Israel3 showed that judges were much more likely to grant parole to an offender in the morning, than they were later in the day.
At the start of a judicial session, parole was granted approximately 70% of the time - but in the afternoon, the decision to grant parole was taken only 10% of the time. Which is a big difference.
As the day wore on, the accumulated effort of making all of these decisions meant that these judges seemingly stopped reviewing each case based on its objective merits and instead increasingly reverted to making the “lower stakes” decision - which was to deny parole.
Put another way, as the judges got tired they started making worse decisions on average.
For us, as investors, there is a very simple way to avoid this kind of decision fatigue. Make fewer decisions.
Bill could be the most informed investor on the planet, a real Warren Buffet 2.0, but past research has shown that even the best hedge fund managers in the world only make the “right” decision 49.6% of the time4. Worse than a coin flip.
Barack Obama, a bloke who knows a thing or two about making high stakes decisions, told Vanity Fair in 2012 “You'll see I only wear grey or blue suits. I'm trying to pare down decisions. I don't want to make decisions about what I'm eating or wearing. Because I have too many other decisions to make.”
I’m sure old Barack, being a fashionable gent, would have liked to have been more ambitious sartorially. But he realised that he only had a certain level of decision making bandwidth available to him, and therefore decided to conserve this for the stuff that was absolutely necessary.
Bob has taken a leaf out of Barack’s book. His investing approach is the financial equivalent of a grey suit - leaving him to focus on the stuff that really moves the dial. Like breakfast.
Have a lovely weekend.
None of the above is intended to represent investment advice. If you have specific queries regarding your individual situation, feel free to email me at david@beechgrovefinancialplanning.co.uk, or consult with a regulated financial adviser.
A profit warning is an announcement made by a publicly listed company to inform investors that its financial results will be significantly below what the market was expecting.
It typically comes ahead of an official earnings release, when management realises the numbers are going to disappoint - due to things like weaker-than-expected sales, rising costs, or a deteriorating economic environment. The company is obliged to disclose this promptly to the market because it constitutes “price-sensitive” information that could materially affect the share price.
Almond please Carol.
Danziger, Levav & Avnaim-Pesso (2011) - “Extraneous factors in judicial decisions”, published in the Proceedings of the National Academy of Sciences.
Rick di Mascio, Inalytics, & Simon Savage, GLG Partners (2009) - “Identifying Manager Skill”, published in the Hedge Fund Journal.