How to get ahead in investing

The path to successful investing lies in avoiding the ‘tyranny of choice’, and concentrating on a small field of investments that can reasonably be expected to deliver good long-term returns. For Tom Bulford, that means small company shares.

A few years ago there was a debate about the number of different types of milk sold by Tesco. This debate was about choice. Given that there were 38 different types of milk on the supermarket’s shelves how could we possibly be expected to know which is best for our own individual diet?

The usual answer is that we should give the consumer all the relevant data and let him make an ‘informed choice’. But which of us has the time or inclination to read the product specifications on 38 different bottles of milk? Would we even understand them anyway? And how would we translate that into a decision about the price and value of each bottle?

And that is just milk. By the time we have completed our weekly shop, making the same assessment of breakfast cereals, washing powder, shampoo and everything else on the shopping list, we would probably find the store had closed for the night.

This is known as the ‘tyranny of choice’ – and I think there is a direct parallel with investing here.

Daniel McFadden, an economist at the University of California, Berkeley, has said that consumers find too many options troubling because of the “risk of misperception and miscalculation, of misunderstanding the available alternatives, of misreading one’s own tastes, of yielding to a moment’s whim and regretting it afterwards” combined with “the stress of information acquisition”.

Today I’ll show you how to counteract those symptoms when you invest…

The importance of delayed gratification

I was reminded of this the other day when I came across a book written by another American academic, Brink Lindsey. The book is called Human Capitalism: How Economic Growth Has Made Us Smarter – and More Unequal. In it, he tries to determine why the gap between the rich and the poor has become so much wider in recent decades.

In 1980, Lindsey says, the average American college graduate received 30% more pay than the average high-school graduate. The gap now is 70%. The top 1% in the United States now receive c.17% of national income. That’s double the figure of 30 years ago.

Inevitably this has been seized upon by politicians, and inevitably their opinions are simplistic and old-fashioned. Politicians on the right argue that it is all in the genes, that able people will naturally rise to the top, and that attempts to prevent this from happening is a waste of effort. From the left, politicians say that it is all the fault of the system, of education and lack of opportunity. This argument has been raging for the best part of a century but, even if it is valid, it fails to explain why the wealth gap has got so much wider in recent years.

 

For Lindsey, the gap starts to appear from the moment that a child is born. Those lucky enough to be born into stable, successful families will be spoken to, will be involved in constructive activities and basically set upon the course to success. The unlucky will be ignored, will receive a bad example and will get little help up the greasy pole of life.

Lindsey offers one particular message that should interest investors. One reason, he argues, that success breeds success is that successful and, frankly, intelligent parents teach their children to defer gratification. While the underprivileged will opt for instant gratification, the more enlightened will invest in their education (in order to secure that premium income), will save their money, and will make some long-term financial plans for their later life.

But to get on in life something more is required, and it takes me back to Tesco’s 38 types of milk.

How to escape the tyranny of choice

If we are going to make the right decisions, we need to be able to cope with the overload of information. Faced with those 38 types of milk, the obvious conclusion is that life is too short to weigh up their individual merits and grab the one with the prettiest packaging, the lowest price, or the one advertised on the TV.

And this, I think, is probably the way that many people choose their investments. They are swamped by the many alternatives, from fine wine to funds, and if they had the inclination to read the small print of all of these competing offers they certainly would lack the time. Overwhelmed by choice, they simply choose whatever seems best at the time and resign themselves to paying out huge fees for a moderate investment return.

But rather than grappling with this undoubted complexity, the best course is to narrow down your investment horizon, concentrating only on a small field of investments that can reasonably be expected to deliver good long-term returns. For me, that means small company shares.

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