Wednesday, August 4, 2010

Why are we such lousy investors? Episode 4: Embracing your inner cave man

Why do most of us earn investment returns far below the market? Why are we such bad investors? In the first installment of this series I explained that our tendency to make poor financial decisions is innate: it comes from our ancestors. In the second session I showed you how our behavior hurts investment returns. And last time I shared with you some strategies that financial planners use to close this behavior gap. In this final segment I'd like to give you a constructive way to think about this problem - a way for you to 'embrace your inner cave man'.

Cave men (and women) weren't all sloped foreheads and grunts, the ones that survived to be our ancestors developed effective strategies to cope with their environment. There's a lot we can learn from them that can help us ensure our financial survival.

Like that the big kill is great but it is roots and berries that keeps us alive - in the investment world it's what you do day in and day out that determines your financial survival - setting and following a consistent savings plan, keeping to a family budget, avoiding extravagant purchases. And if by chance your tribe kills a 'financial mastadon' great! But build your future around things that you can do, not things beyond your control.

Don't make bets that you can't afford to lose. I don't know this for sure but I'll bet when the tribe found one of those hairy elephants our ancestors weren't on the front line where they could be trampled. Part of the hunting band, yes, but a few steps back so as to take advantage of the fresh meat at a reasonable risk to life and limb. It's the same with our investments.

Leverage the wisdom of the tribe. For a cave man to live to a ripe old age was quite an achievement. And the 'tricks' and 'techniques' that the tribal elders had perfected were incredibly valuable. The wise cave man spent as much 'quality time' with these 'survival experts' as he could - asking them questions and getting their advice on how to navigate a dangerous world. Likewise you should take advantage of the financial, legal and tax experts available to you. While they're not necessarily older than you, they have critical expertise that can help ensure your financial survival.

So there you have it: You're inner cave man can get you into investing trouble as well as get you out.  I'll bet you never thought you could learn anything from a cave man.

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