Can we overcome emotion when investing?

Written by: Quilter Cheviot Posted: 25/09/2019

Chris Woodward_QuilterSlowing down, analysing your decisions and double-checking your assumptions can lead to better investment outcomes, finds Chris Woodward (pictured), Jersey-based Trainee Investment Manager at Quilter Cheviot Investment Management

Do you consider yourself a brave person? Are you willing to find out? This was the killer question behind Derren Brown’s 2018 TV show, Sacrifice. In the show, Brown attempts to get US citizen Phil to take a bullet for another man, a Mexican immigrant who is being attacked by a biker gang. 

Phil has already expressed anti-Mexican sentiments during his recruitment for the show, so it is surprising when he eventually intervenes to save the life of the Mexican man. By subtly promoting Phil’s empathetic side in the weeks before the shooting incident, Brown apparently changes how Phil would act, leading Phil to save the life of a man he would otherwise have allowed to die. 

What’s particularly interesting about Sacrifice is that it raises the possibility that we are all able to ‘hack’ our brains to simplify our lives and make ourselves better. And this has parallels with investing, where trying to make rational decisions without the fog of human emotion is of paramount importance. 

In fact, Barclays Bank estimates that emotions lead the average investor to suffer between 2% and 3% in foregone returns every year. 

Of course, Brown’s experiment is slightly different to the area I wanted to look into. Sacrifice demonstrates how emotions can lead us to act in a certain way. My own thought was whether we could start to rule out emotion completely. So I started to look into the role of emotions and investing, and I came across quite a few interesting discoveries. 

Making decisions without emotion

Fortunately, the role of emotions in decision-making has received a lot of attention in recent years. There is even a new discipline for this, neuroeconomics, which brings together neuroscience and economics and looks at how the two can provide insights into their respective fields.
Thanks to the work of neuroeconomists, we have studies comparing how different people make investment decisions. In ‘The dark side of emotion in decision-making’, published in Cognitive Brain Research, Baba Shiv, George Loewenstein and Antoine Bechara looked at the decision-making process of people with brain damage due to substance dependence, specifically looking at whether their decreased emotional reactions allowed them to take better investment decisions.*
Introducing the study, Shiv, Loewenstein and Bechara cite the real-life example of someone with brain damage who was driving a car that hit an icy section of road. While the other drivers hit their brakes in panic, the driver’s lack of emotion – specifically fear – allowed him to remember that not hitting the brakes was the correct reaction. 
BL64_Quilter Cheviot illoThe study went on to look at three groups of people – people with brain damage, no brain damage, and brain damage due to substance dependency. Each participant was given $20, which they were told to treat as real as it was their compensation for taking part in the study. 

Over 20 rounds, they had to decide between two options: invest $1 or do nothing. If they invested, they had a 50/50 chance of either losing their $1, or keeping their initial dollar stake and gaining an additional $2.50. 

As the expected value on each round ($1.25) is higher than if one does not invest ($1), the correct decision would have been to invest in each round. If you did invest in each round, you would have only a 13% chance of earning less than if you just pocketed the $20. 

The results of the study showed that people with brain damage – from substance abuse or not – tended to make decisions that maximised profits more than those without brain damage. Those with brain damage ‘were not influenced by the emotional reactions associated with the outcomes of preceding rounds, so that they were more predisposed to taking risks’.**

Of course, this does not mean that we should all try to disregard human emotion completely. As the authors of the study put it, many of the participants with substance-induced brain damage suffered from poor decision-making in real life, and their better performance was ‘likely the direct consequence of the emotional indifference about losses, and their willingness to risk punishment in order to obtain reward’.***

Can we become better investors?

But if emotion can hold us back from taking the right decisions, can we actually suppress our emotions to make us better investors? To an extent, this is what a lot of people do already. Staying invested no matter what, or drip-feeding money into markets on a regular basis are both strategies that remove the need to take decisions and thus remove the wrecking ball of emotion. 

There is plenty of research on how we can take better decisions. Perhaps the most interesting example is the Good Judgment Project (GJP), the brainchild of Canadian-American scientist Philip Tetlock. Tetlock wanted to test the accuracy of expert predictions and find out whether their specialist forecasts were any better than those of the man in the street. 

In 2011, the Intelligence Advanced Research Projects Activity (IARPA) – a branch of US intelligence – launched a competition to identify cutting-edge methods to forecast geopolitical events. Five scientific teams competed to generate forecasts on the type of questions US intelligence agencies needed answering every day. 

The competition was unprecedented, partly because it was one of the few attempts to measure the accuracy of US intelligence forecasts, but also because it generated an unparalleled dataset on what forecasting methods worked. 

More than one million questions later, Tetlock’s GJP emerged on top. In year one, the GJP team managed to beat the official control group by 60%. In year two, that gap widened to 78%. By the end of the second year, the GJP team was doing so well that IARPA dropped their academic competitors. The team had even managed to outperform intelligence analysts who had access to classified data.

How could a team of outsiders perform better than America’s foremost intelligence experts? The answer to this question lies in how far you are prepared to analyse your decisions. Tetlock and his team identified a group of individuals – superforecasters – who were particularly skilful at making predictions.

These individuals were far more open-minded in their thinking and deliberately tried to cultivate their forecasting ability. When forecasters practised assigning precise probabilities to the predictions, for example, they became better at distinguishing finer degrees of uncertainty. 

Answer, check the answer, repeat

Much of what happens is about double-checking yourself. Take the following question, for example: you have two tokens in your pocket, which together are worth £1.10. If token one is worth £1 more than token two, how much is token one worth? If you immediately answered £1, think again. The correct answer is actually £1.05.
When answering a question, the majority of us reach for the simple answer. Few people bother to check that the value of their answers actually adds up to £1.10. If you do, you quickly discover your elemental mistake and come up with the answer relatively easily. 

Making better investment decisions might therefore appear deceptively simple – you think carefully about your decision and then double-check your assumptions. This is hard to do in practice though. If you want to become a better investor, slow down and think. And if you don’t have time to slow down, you can always appoint a bespoke investment manager! 

* The dark side of emotion in decision-making: when individuals with decreased emotional reactions make more advantageous decisions. Shiv, Loewenstein and Bechara. Cognitive Brain Research 23 (2005)
** Ibid., p89
*** Ibid., p91

For more information, please contact Chris Woodward, Trainee Investment Manager, Quilter Cheviot Investment Management, at

Investors should remember that the value of investments, and the income from them, can go down as well as up. Investors may not recover what they invest. Past performance is no guarantee of future results. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

Quilter Cheviot
Quilter Cheviot, part of Quilter plc, is one of the UK’s largest discretionary investment firms and can trace its heritage to 1771. The firm is based in 12 locations across the UK, Jersey and Ireland and has total funds under management of £24.1bn (as at 30 June 2019). Quilter Cheviot focuses primarily on structuring and managing bespoke discretionary portfolios for private clients, charities, trusts, pension funds and intermediaries.

Quilter Cheviot Limited is registered in England with number 01923571, registered office at One Kingsway, London, WC2B 6AN, England. Quilter Cheviot Limited is a member of the London Stock Exchange; is authorised and regulated by the UK Financial Conduct Authority; has established a branch in Jersey and is regulated under the Financial Services (Jersey) Law 1998 by the Jersey Financial Services Commission for the conduct of investment business in Jersey and by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law, 1987 to carry on investment business in the Bailiwick of Guernsey; is regulated by the Dubai Financial Services Authority as a Representative Office (and its business name in Dubai is Quilter Cheviot Limited (DIFC Representative Office)). Quilter Cheviot Europe Limited, trading as Quilter Cheviot and Quilter Cheviot Investment Management, is regulated by the Central Bank of Ireland. Registered in Ireland: No. 643307. Registered Office: Hambleden House, 19-26 Lower Pembroke Street, Dublin D02 WV96. Accordingly, in some respects the regulatory system that applies will be different from that of the United Kingdom.

• This advertising feature was first published in the September/October edition of Businesslife magazine

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