Warning! No Lifeguards On Duty

The comments below are an edited and abridged synopsis of an article by Michael Lebowitz and Jack Scott

In a poll by the CFA Institute of America, readers, many of whom are professional investors, were asked which behavioural biases most affect investment decisions.

Warning! No Lifeguards On Duty | BullionBuzz
A lifeguard tower sits on a flooded beach with a foggy background.

Compounding wealth, which should be every investor’s primary objective, depends on avoiding large losses. Based on the poll, loss aversion was the lowest-ranked bias.

Cognitive biases impair the ability to remain emotionally disconnected from money. History clearly shows that investors always do the opposite of what they should when it comes to investing their own money.

The same biases driving markets higher today also drove irrational conduct in the late 1920s and the late 1990s. Currently, valuations are at or near levels reached during those market peaks. Current valuations have long since surpassed all other prior valuation peaks.

One major difference between the late 1920s, the late 1990s, and today is the extent to which the Fed is fostering current market conditions and imprudent investor behaviour. To what extent have investors fallen into the overconfidence trap as the herd marches onward? It raises serious questions, especially in light of recent changes in Fed policy.

Today, irrational behavioural biases are the mindset of the market. There are few who know what to look for in terms of distress. Those who do are sounding the alarm. Thus far, warnings go largely unheeded because of blind confidence in the Fed, and profits are blinding investors.

Investors should evaluate a list of cognitive biases, and be aware of their weaknesses. Humility will be an enormous asset as this economic and market expansion ends, and the inevitable correction takes shape. 

Finally, we must ask what asset can be a life preserver? What is neither being chased higher by the herd nor providing any confirmation bias? And the answer is: gold.

Gold provides ballast to a portfolio during troubling times and should definitely be considered as the distress becomes more pronounced and obvious.

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