Youre a goalkeeper about to face a penalty kick. The speed the ball is likely totravel at means you must decide how to respond beforeitsstruck. More likely than not, youll choose to diveto your left or right.Thats unfortunate.In an analysis of 286 penalty kicks taken in elite matches, it wasfound that keepers saved a third of penalties by standing still. This compared favourably to when they jumped to the left (14.2% saved) and to the right (12.6% saved).
Goalkeepers shouldntbeat themselvesup. The need to do somethingis called action bias and it has a long history. Back in prehistorictimes, this tendency served us well. Farbetterto run with the herdthan risk being gobbled up by a predator. In the modern day however, this can be counterproductive. Nowhere is this more evident than with investing.
Why its so hard to staystill
A great example of action bias was theaftermath of the EUreferendum vote. Back in June, a lot of people jettisonedexcellent companies from their portfolios thanks tothe uncertainty grippingthe market. Like our ancestors, theysensed a threat, saw what others were doing and responded accordingly. So far, so human.
Unfortunately, this lost a lot of people a lot of money. Others, sensing a market overreaction, began hoovering up the shares and the markets rebounded. Even if the first grouprepurchased their shares (probably at a higher price), they still paid up in commission costs and stamp duty to do so.
This is one instanceof the temptation to act. Investors also have to contend with the scarcity effect(What if this is my last chance to buy cheap?), boredom (When will something happen to the share price?) and the desire for quick returns (Need bigger profitsthis month.)
This doesnt mean that acting is always a bad idea. Hindsight allows us to see thatthose with shorter investing horizonsmay have been better off sellingtheir shares in Tesco, Restaurant Groupor Sports Direct. The point is we need to distinguish sound investing decisions from the urgeto do something, anything, with our investments.
Build a quiet room
The first way ofdefending ourselves against action biasis to recognise our susceptibility to it. If youre planning to make alterations to your portfolio, question your reasons for doing so. If this happens during times of market turmoil, recognisethat standing stillwhile othersfret wont kill you.
Next, focus onbuying a diverse group of resilient companies with competitive advantages. Theyll have long histories of growing earnings and delivering high returns on capital employed (ROCE).If we set out to buy the right companies for a fair price, we reduce the need to act further down the line.
To further reduce this habit, we couldalso pay a little less attention to how the markets are behaving. If thismakes usuncomfortable, we couldsign up to newsalerts from thecompanies weown. This way, weneatly avoid lots of irrelevant, panic-inducing noise, allowing us to make informed, stock-specific decisions.
French mathematician Blaise Pascal once reflected that a lot of our problems derive from not being able to sit in a quiet room alone. Know when to occupy yours.
One other thing you should do
Learning the identity ofyour greatestadversary is one of biggest challenges in investing. It’s not other private investors, day traders or the big institutions. Rather, it’s likely to be the very person staring back at you in the mirror.
Our tendency to act rather than reflect is understandablebut potentially very damaging for our finances.If you’re keen to avoid making expensive errorsin your investing career, I strongly suggest you read a special FREE report produced by the experts at the Motley Fool. The worst mistakes investors makecontains some excellent hints and tips on how youcan avoid making the most common blunders.
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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.