How the Illusion of Control can Deceive an Investor
Why do so many people choose their favorite number combination when playing the lottery? Perhaps they are trying to turn a game of chance into a game of skill. Most hold a special meaning behind their numbers (for instance, significant dates), while others simply have lucky numbers. Regardless of how convincing these self-justifications seem to be, there is no scientific support for their choices. When the wheel spins, all numbers are equal.
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, despite there being no rational reason for this belief. The Illusion of control is heightened by stressful and high-stakes situations. 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. Using an innovative computer task, designed to assess the illusion of control in the field, researchers tracked the relationship between investor performance and their behavior related bias. Results showed that the traders who were heavily influenced by the illusion of control 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 – they stick 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, one that ensures that all future returns will contribute to your financial success. It’s called diversification, a strategic approach to investing.
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, anchored by an individual’s risk tolerance, goals, and priorities. When used correctly, diversification minimizes risks, while at the same time, increasing risk tolerance. It is a strategy that you should consider if you are looking toward your long-term goals, since the returns will be great 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.