Why do so many people gravitate toward 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 is 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.
The Illusion of Control can have significant consequences in various areas of life, including investing. The belief that one can influence the outcome of a financial transaction may lead to irrational decision-making, resulting in significant losses. The experiment conducted on traders highlights the negative impact of the illusion of control on performance. Traders who believed that they could control the outcome of their investments performed worse than those who were less influenced by the illusion. This suggests that being aware of this cognitive bias can be beneficial in making more rational decisions, particularly in high-stakes situations. Recognizing that certain events are out of our control can help to reduce stress and improve decision-making, leading to better outcomes in the long run.
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.
Furthermore, investors who succumb to the illusion of control tend to make emotional decisions and trade too frequently, which can result in higher transaction costs and lower returns. This behavior can be particularly problematic during market downturns, when the temptation to sell stocks in a panic can lead to significant losses.
What Can You Do?
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.
While diversification does not guarantee success, it can help investors avoid the pitfalls of the illusion of control and make more rational decisions. It also allows investors to take advantage of the opportunities offered by international markets, potentially increasing their wealth in the process. By adopting a diversified approach to investing, investors can take a step towards financial success, while reducing the impact of the illusion of control on their decisions.
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.
If you’re looking to overcome the illusion of control and improve your financial outcomes, we invite you to contact us to learn more about our investment solutions and how we can help you achieve your financial goals.