The Seven Deadly Sins of Multi-Asset Investing
Updated: May 19, 2022
Investing is an activity that’s rife with opportunity to fall into bad habits, be led astray or make decisions for the wrong reasons. Being aware of the behavioural traps and temptations that lie in wait for the unwary investor is the first step to avoiding them.
"A less lusty approach almost always proves more fruitful in the long term"
The Seven Deadly Sins were formulated in early Christian teachings to make followers mindful of man’s natural vices – lust, gluttony, greed, sloth, wrath, envy and pride.
On the following pages, we’re adapting The Seven Deadly Sins to the world of multi-asset investment, revealing the all-too-common investor tendencies that we look to avoid in order to achieve reliable long-term performance for our clients.
Lust (luxuria) - Resist the siren call of short-term opportunity.
Investing for the long-term sounds like an obvious strategy but it is surprising how few investors actually adopt it. In our fast-paced world, the desire for instant gratification can overwhelm. The prospect of immediate gain invites attempts to try to ‘time’ a sector or stock – often with disastrous consequences – or to pile into whatever is the flavour of the month long after the opportunity to profit has passed.
Equally, the urge to crystallise profits can cause quality assets to be sold well before they reach fair value. Moving in and out of markets or asset classes can suggest an active passion for investing – but often only incurs losses as well as the ubiquitous trading costs. A less lusty approach that weathers market ups and downs over years, not just weeks, almost always proves more fruitful – as well as cheaper – in the long term.
Gluttony (gula) - When it comes to information, less is very often more
In a data-overloaded world it is easy to gorge on information. But analysis that involves lots of inputs is not necessarily more effective. Simpler but disciplined analytical frameworks can be the most robust. When evaluating asset classes, for example, the simplest approach is to look at yields and growth prospects. If valuations are high (and therefore yields are low), the chances are that valuations will fall (and therefore yields will rise). Conversely, if yields are high, there’s a good chance that they will fall and valuations rise.
Having the discipline to screen out market noise also means resisting the temptation to change your basis for valuation every time a new fad comes along. People lost fortunes in the dot.com bubble by being attracted to fashionable new metrics such as counting eyeballs, instead of analysing company cashflow. Keeping your basis for selecting equities or bonds sound and lean is arguably the key to rich pickings.
Greed (avaritia) - If everyone else is investing, probably best you don’t
Whether it’s equities, bonds or property, the avarice of the herd is always to be treated with caution. The periods when a sector is rocketing, and investors are piling in at any price can be the time to steer clear (or quietly sell). Conversely the time when the market is getting agitated and bailing out can provide rich territory for smart, selective investors who know what they want to buy and why.
Patience is paramount, however. If you have a strong conviction about a company or asset class, it may take a while for others to come round to your point of view. During this time, prices may move against you, requiring mental strength to stick with your position.
Equal discipline is required to keep your portfolio balanced. If everyone is moving to equities, it can be tempting to sacrifice your fixed income exposure. But with that, you could also jettison your risk diversification. Wherever you invest, invest for the right reasons.
Sloth (acedia) - In investing there are no short cuts
Investing is easy. Understanding what you’re investing in is a completely different matter.
With Aberdeen multi-asset portfolios, we only invest in what we really know and like. In fundamental equity investing, that means doing all the hard work to get to understand every single company first hand – finding out where performance is coming from and how it can be sustained in the future. Likewise in bonds, we don’t just look at yield; we measure it against other valuable criteria, such as default rates, the underlying nature of the company and industry (or economy). Only through this grunt work do we really understand what the right valuation for an investment should be.
From some vantage points, sloth is one of the better sins. If we have chosen the right business in which to invest, it is often best to let the stock grow without fussing over it or trading unduly.
So our moral is not to be lazy in doing due diligence, but rest comfortably once a sound long-term decision has been made.
Wrath (ira) - Being diversified is the key to calm, even in volatile markets
Markets are plummeting, the outlook is bleak and everyone is selling. But if your portfolio is properly diversified you can afford to be an oasis of calm. There are rare cases when the majority of asset classes have fallen in tandem (the 2008 global credit crisis), but usually it’s a case of swings and roundabouts.
If equities are falling and interest rates are being cut, then your exposure to fixed income is likely to be standing firm. Equally, if inflation is threatening to rise, equity and commodity exposure may hold you in good stead even if your bond holdings fall.
The wrath and unpredictability of markets can be daunting. Allocating to the highest-quality assets you can find across a spread of lowly-correlated asset classes remains arguably the most sensible protection.
Envy (invidia) - Imitating the index is the poorest form of flattery
‘Benchmark hugging’ is a cardinal sin of the ‘active’ investor. This deviant behaviour, especially among professional investors, is driven largely by fear. After all, if you follow your benchmark index at least you can’t be sacked for underperforming it.
The sin with this approach is partly that it’s lazy and unthinking. It means you are constantly investing only in assets that have done well in the past, rather than those that might do well in the future (stocks only enter indices following good performance and leave after poor).
When constructing a portfolio, it might be a good idea to take little or no notice of market indices but to invest in those assets that offer the best potential for future return at an appropriate level of risk. This gives you the freedom to invest only in what you really rate – with no obligation to hold anything simply because it’s in the index.
Modern multi-asset strategies judge their performance not against a relative market index but against the tangible and absolute concept of a risk-free return – like cold hard cash. For many risk-averse investors, that’s a benchmark well worth outperforming.
Pride (superbia) - Over confidence comes before a fall
It’s a human survival instinct to be overconfident – note the survey from a Swedish psychology journal, where 93% of American motorists claimed they were ‘above average’ drivers.
The natural tendency to be overconfident in one’s own abilities is fatal for investors. It leads them to make judgements based on inadequate information, overestimate the accuracy of their predictions and believe they aren’t prey to the same mistakes as everyone else. Overconfident investors, as a result, often make the same mistakes over and over again.
What’s more, people stay overconfident even when they have made mistakes that highlight the errors of their own judgement. In these circumstances, people are likely to blame events outside of their control. So when an asset in a portfolio goes up, an investor is likely to take the credit. When it falls, they’re more likely to blame unforeseen events.
Whatever your assessment of your own confidence, spending more time asking yourself why your judgement could be wrong, rather than gathering proof that it is right, can lead to a better outcome.
Hindsight is a wonderful thing – particularly in investment markets, where instinct and emotion all too often override sense and logic. So for anyone looking to buy (or sell) an investment, we hope this booklet proves an enduring reminder just to pause, consider, and think hard before taking action.
Being a ‘virtuous’ investor is clearly a challenge. It demands that you resist impulsive behaviour, screen out market noise, remain thorough in your research and stay calm and dispassionate whatever market conditions you face.
But armed with the knowledge of which vices to avoid, hopefully those good habits can now become a little easier to cultivate.
Published in Aberdeen marketing
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.