How the Illusion of Control can Deceive an Investor
Why do so many people gravitate towards their favorite number combination when playing the lottery? Perhaps they are trying to turn a game of chance into a game of skill. Most people hold some special meaning behind their numbers (for instance, significant dates). Other people simply have lucky numbers. These self-justifications may seem convincing at first. However, we see that there is no scientific support for their choices. When the wheel spins, all numbers are equal.
What is the Illusion of Control?
In psychology, this cognitive bias is known as the ‘illusion of control’. It is a phenomenon that describes the tendency of people to think that they have the power to influence future outcomes. We see this even when there being no rational reason for this belief. Stressful and high-stakes situations heighten the Illusion of control. In the previous example, people believed that their treasured numbers combinations would earn them enormous wealth.
In an experiment published by the Journal of Occupational and Organizational Psychology, researchers studied the behavior of over 100 traders from various banks in London. Researchers used an innovative computer task, designed to assess the illusion of control in the field. They tracked the relationship between investor performance and their behavior related bias. Results showed that the more heavily influenced traders earned less.
In the real world, the illusion of control is evident in investors’ tendencies to avoid international investments. Many of them feel that they are more in control of investments in their own countries. As a consequence, they miss opportunities to increase their wealth. This results from sticking to a one-dimensional strategy that actually carries more risk.
The good news is that there is a more efficient way to manage your portfolio. This approach ensures that all future returns will contribute to your financial success. It’s called diversification, a strategic approach to investing.
What can you do?
A globally diversified portfolio can help an investor achieve the ideal balance. A healthy portfolio is one that is composed of mixed assets (fixed income investments, equities, hard assets, etc.) that are scientifically placed into multiple global markets. The individual’s risk tolerance, goals, and priorities anchor these markets. When used correctly, diversification minimizes risks, and increases risk tolerance at the same time. It is a strategy that you should consider if you are looking toward your long-term goals. With this approach, the returns will grow much more over time.
At LexION Capital, our priority is to produce well-diversified portfolios by scouring the world for the best international investments. Our team provides data-driven and scientific insights that aid in diversifying clients’ assets, based on personal goals and priorities.