I was in Kinokuniya Bookstore during the Christmas weekend to search for some behavioral finance books to add to my collection. I was looking for a writer who could present more than psychology on this topic. The subject should touch beyond investment management issues and include overall personal finance. I always look beyond the psychology as the cause of behavioral change in clients, perhaps getting more input from other social science aspect and religious teachings, but however it is hard to get one. Suddenly, I noticed a book titled “Beyond Wealth” written by an investment advisor and financial writer, Alexander Green. Without any hesitation, I grabbed the book.
After flicking through a few chapters, I found that ignorance is the only reason that leads us to have wrong perception and make wrong decisions in managing our wealth. Ignorance may be rooted in our own ego, delusions or limited exposure, but we will not discuss philosophy here. What makes me more interested is how ignorance is related to psychology and then to financial management or decisions. I am just eager to explore and share it with you. The subject of ignorance is not easy to discuss, because some of us, especially Asians, do not like to be told directly or labeled ‘Ignorant’. It can be sensitive to some, but I hope that by sharing this subject, we will get a wake-up call and become more
rational in our financial decisions after the many financial crisis and scandals over the last couple of decades.
The primary – Ignorance
Recently Bank Negara had announced a few scams involving gold investment companies and many investors lost a great chunk of money investing in these scams. Some even went to the extent of putting their entire savings into the scam scheme to fund their children’s education or their own retirement income. It is still chaos for the investors out there, with some still blaming the government and Bank Negara for wrong or slow action. Many investors have suffered badly… and sadly. Just like my good friend who is an agent cum investor, he just stopped my conversation in my last call to him and said, “Aiyah…don’t want to talk anymore lah…very sad”. I was told that he earned easily close to RM9,000 per month from this investment for some time before the freezing of the gold investment company took place, while enjoying other good business income. Does it sounds lucrative? Yes, of course…but there is a price to pay for something too good to be true.
This incident makes me more interested to discover how humans make decisions and are motivated to gear deeper into the scheme. It is not the Ponzi scheme that I would like to highlight, nor is it the greed that is the cause as claimed by many. Many investors or observers just settle at greed as the origin of problem, but greed could not arise if there is no ignorance. Therefore, ignorance is the main cause of the disaster.
The gold scheme scandal is not much different from Madoff’s Ponzi scheme scandal which surfaced in 2008 in the United States of America. We shake our heads in disbelief during that time. But now, we have our very own Malaysian scam. Does this mean that we do not learn from past incidents? Or is it too hard to believe that it can happen to Malay- sians? Indeed, it is very difficult to resist the carrot of a lucrative investment return. Our sub-conscious mind may not hesitate to accept, even though the conscious mind is supposed to investigate and see the irrational promise of high and consistent returns from the invest-
ment scheme, regardless of market or economic cycle.
Developing Psychological Biases
Once we allow ignorance to happen, we are easily swayed by psychological influences. These psychological biases are stimulated by either external attractive boosters or our self-triggers.
In the current economic turbulence, there is massive news available on the potential growth of gold asset. Especially after the Global Financial Crisis in 2008, we easily develop an ‘Availability Bias’ based on the belief that the more good news we hear, the higher our confidence level. This is supported by the fact that gold prices have really skyrocketed in recent years. Hence, this is the perfect opportunity for the gold scheme company to bombard us with selective information to attract us. This catches our heart because we usually hear what we like to hear and are clouded by lucrative promises. When we notice more and more friends getting involved in the
scheme, many of us would follow, disregarding our initial doubts. At this stage, we simply have the ‘Herd Mentality’.
After going through personal invest- ment and seeing handsome returns, we tend to become overconfident and believe that the trend of growth will be a ‘bull’. It is at this ‘Hindsight Bias’ stage when we think the future is easier to predict by anchoring to our past success. We would overreact to more exciting news and become greedy.
By this time, we are no longer the people of our past. The doubt has disappeared, even though the scheme looked suspicious to us in the beginning. It has become our affirmation. At this stage, it is not easy for others to enlighten us away from this process of ignorance, even if the good advice is given by those closest to us – even our spouse or parents. We have simply developed “Confirmation Bias’. We would try to defend our decision and are still unaware of the delusion.
To act rationally in making any investment and personal finance decision is not an easy task. Apart from logical thinking and the need for due diligence on any suspicious investment scheme, we need to understand our investment or personal finance philosophy and our current financial objective and constraint.
We should seek qualified and experienced financial advisers who could give us wise financial advice. The best financial advisers would be able to translate our philosophy and limitation into a practical strategy to mitigate investment and financial risks. This will help us to avoid irrational decisions and actions based on psychological biases.