Extraordinarily compelling evidence

25Apr09

Much of our linkfests are dedicated to providing readers with new investment ideas and concepts.  However we recognize that investing, contrary to appearances, is in fact difficult to master.  A post at Trader’s Narrative this week talks about the time and effort required to become an “expert trader.”  For most people the effort required is much more than they thought.

Even in these difficult economic times, there is no shortage of investment ideas and strategies battling for investors’ attentions.  Trying to sort through them without some measuring stick is an receipe for disaster.  What investors need is some standard by which they can judge the merit of new investment ideas.

Jason Zweig at WSJ.com has a piece up which discusses the many ways in which group decision making can go wrong.  The recent past provides us with any number of ways in which investment decisions can go off track.  One of the remedies struck us as particularly relevant:

Define the default position. Max Bazerman, an expert on decision-making at Harvard Business School, suggests that investors start with the assumption that the ideal portfolio is a diversified basket of low-cost index funds. Any deviation from that strategy should require extraordinarily compelling evidence.

Dr. Brett notes that a common finding in the behavioral finance literature is that traders are overconfident.  This then leads to overtrading.  One way to avoid this vicious cycle is to have some standards, or hurdle over which new strategies need to clear.

We have written in the past about how in today’s world of ETFs one can create a globally diversified portfolio at a shockingly low expense ratio.  This is a good starting place, but each investor may have a different benchmark portfolio.  The relevant point not the benchmark, but the standard.  If not, you are going to be swayed by the many voices out there trying to get your attention.

In short be on the look out for “extraodinarily compelling evidence.”  Anything less than that is an invitation for trading troubles.

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One Response to “Extraordinarily compelling evidence”

  1. Couldn’t have said it better myself. Well done!


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