Goldilocks had it easy. There were only three bowls of porridge, and her downside risk was a burnt tongue and a bad night's sleep.
It’s much more comfortable to make a decision when presented with only a few options. House Hunters International has nailed this dynamic with three neat choices in under thirty minutes. If one’s too hot and one’s too cold, just peek behind door number three.
As the number of choices grow, our brains begin to play tricks on us. We start to make decisions based on the availability heuristic - applying more weight to anecdotal evidence. Loss aversion also comes into play, as Prospect Theory has shown we’re more risk acceptant when losses are on the tables than when gains are.
There are both general human biases, and individual specific biases. Highly skilled people may suffer from the Dunning Kruger effect, but we all enjoy a nice theory that fits our Confirmation Bias.
At the end of the day, we’re only capable of making so many decisions and our faculties eventually wear thin. Did you think that Steve Jobs wore the same turtleneck for fashion reasons?
As investors, we’re bombarded by a Goldilocks fun house. Wandering through the forest trying to manage uncertainty, there are dozens of cottages along the way. Porridge, gruel, and mush of all flavors. The breadth of choice is deafening and often leads to decision paralysis.
When we think about investment decisions, the first word that comes to everyone’s mind is risk. Advisors must understand client risk tolerance, traders have risk managers, and be sure to remember that all investments carry the risk of loss.
But risk is not synonymous with the stock market going down and low risk investments aren’t just a bond portfolio. Risk is multidimensional and is as much about what doesn’t happen as what does. Not taking risk is a risk.
We intuitively understand this in our personal lives. When humans take non financial risk - trying a new food or visiting a new place - they tend to experience greater happiness and self confidence. As painful as getting off your couch is after a long week, the fear of missing out (FOMO) on the fun at your friend’s birthday party is enough to motivate.
When evaluating different financial risks, it’s easy to keep cash in our portfolio because the market risk of investing in a stock is staring us right in the face. What if it goes down? The longer term degradation of purchasing power feels like an academic figment - until you’re paying 9% more for groceries this year than last year.
Portfolio management is a moving target. As our objectives evolve against the opportunity landscape, there is a constant adjustment process. Yesterday’s safe haven is tomorrow’s dead weight.
Embracing your inner FOMO when it comes to investing is not about jumping on every opportunity. It’s about keeping a wide eyed perspective on what the biggest risk is. The cornucopia of choice offered by the market ensures there is something to manage those risks for every type of investor.
Spending time getting ready to go out, or evaluating your portfolio is a short term cost for future success. Investments serve their purpose when you don’t miss out on the things that provide you joy and contentment.