12 Dec 2018

Three ways to make sound investment choices

Patrick Lawlor

Editor

Overwhelmed by investment choices? Try these ways to help you decide.

The investment world, much like the consumer world, contains a bewildering array of choices. While we have grown up believing that more choice is a good thing, various studies have shown that this is not necessarily the case. Sheena Iyengar, a Columbia University professor of business and author of the book The Art of Choosing, details how a large number of choices may even make us worse off, rather than better.

 

Iyengar pioneered the famous jam test, whereby one group of customers in a supermarket was offered a small variety of flavours of jam to try, while another group was offered a large variety (customers who tried the jams were given vouchers to redeem on purchases of jam). Those customers offered a smaller variety to try turned out to be more likely to make a purchase than those faced with a larger variety to choose from. The greater the variety, the more anxious the customers became about making the wrong choice – so much so that they often opted out of making any choice at all.

 

Subsequent studies have shown similar results for investments and medical insurance. Faced with too much choice, people put off the decision for a long time, or even allow the decision to lapse. Even those who do make a choice often end up making the wrong ones. A study of choices made by investors in 401(k) plans in the US – this refers to a US retirement savings plan, sponsored by an employer – showed that over time, investors often opted for money market or bond funds over equity funds, even over long-term horizons, despite equities generally outperforming other asset classes over long periods.

 

Iyengar's studies have encouraged many companies to trim down the number of products they offer; for example, Procter & Gamble reduced the number of Head & Shoulders shampoo varieties from 26 to 15, and saw sales rise 10% as a result.

Many investment firms have also consolidated their offerings in order to make life simpler for investors and, in so doing, encourage investment.

 

But life and business is not quite that simple. As a species, we seem to value more choice (one hypothesis is that the ancient hunter-gatherers evolved that way, to seek out more varieties of food and thus develop a more balanced diet). Providers of those choices seem happy to oblige us with still more.

 

It seems too much to ask to expect providers to limit choices in every field. Iyengar says we seem comfortable with a variety of choices of about seven – any more, and our anxieties and poor decision-making kick in.

 

Moreover, striving too hard to limit choice may deprive us over time of better products. What if the extra choices really are better for us than the old choices? And in some areas we really do benefit from extra choice – imagine a bookshop that only stocked seven book titles (more on this below).

 

If we can’t limit the number of choices, what can we do? The trite answer is to become better at making choices. But this is easier said than done. Try these suggestions as a start:

 

1. Upskill yourself

While we can always become more skilled in a particular field and thus become better at deciding between the options available, we cannot become experts in every field. A wine fundi in a supermarket will have no trouble discerning between the different chardonnays or chenins. The fundi may even enjoy a bigger selection. However, not everyone can be a wine expert, a gadget-loving geek or an investment specialist. In some areas, one requires more than just an interest in the field. Years of diligent study may be required.

 

2. Break it down

Another possible answer is to break down our choices into categories. In the bookshop example above, by breaking our reading down into genres, we can help the decision process. Pick a genre (crime fiction, biography, business, etc), then break it down from there (Swedish detective novels, World War II generals, entrepreneurship, and so on). This process works best where there are discernible differences between the choices on offer.

 

3. Trust the professionals 

Where neither of these approaches is viable, you should probably entrust your decision-making to a professional. This is probably the advice you'd give to anyone wishing to invest in the market (provided the professional has an impeccable record and aligns his or her interests with yours). Even here, the individual should not leave everything to the adviser. Those who engage in the decision-making process, who are not shy to ask lots of questions and to get to grips with exactly what it is they want, probably stand a better chance of getting the most out of the provider, whether it be a plumber, an interior decorator or an investment manager.

 

Here's to making excellent choices.

About the author

Patrick Lawlor

Patrick Lawlor

Editor

Patrick writes and edits content for Investec Wealth & Investment, and Corporate and Institutional Banking, including editing the Daily View, Monthly View and One Magazine - an online publication for Investec's Wealth clients. Patrick was a financial journalist for many years for publications such as Financial Mail, Finweek and Business Report. He holds a BA and a PDM (Bus.Admin.) both from Wits University.

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