It’s comforting to feel we’re in control. But are we?
When we play Monopoly, it doesn’t matter whether we roll the dice or let somebody roll for us—and yet we sense that we’ll fare better if we do it ourselves. Want a high number, so we leap past the hotels that another player has built on Boardwalk and Park Place? We’ll shake the dice extra hard.
Similarly, on many “one-arm bandit” slot machines, we can choose to either push a button or pull a lever. We figure we’re more likely to get three cherries in a row if we make the extra effort, so we reach for the lever. Buying a lottery ticket? We reckon our odds of winning are higher if we use our lucky numbers, rather than relying on random numbers generated by the ticket machine.
Welcome to the illusion of control, the tendency for folks to believe they have more control over events than they really do.
In each of the above instances, we’re fooling ourselves—something most of us will cheerfully admit, even as we give the dice an extra hard shake. Here’s something we are less willing to admit: We embrace the same illusion when investing.
Admittedly, managing money is a tad different from games of chance. There’s much that we can control, including how much of our money is in stocks, how diversified our stock portfolio is and how much we pay in annual fund expenses.
But having made those decisions and invested our hard-earned money, our subsequent performance is largely out of our control. Markets are driven by news, and news—by definition—is unpredictable. We can stack the odds in our favor by managing risk, holding down taxes and minimizing investment costs. But we don’t fully control the outcome.
For many, this is an unpalatable thought, which is why we check the Dow Jones Industrial Average four times a day, keep the TV tuned to CNBC and review our portfolio’s value after the market closes. None of these activities will improve our investment results, and yet it feels like we’re making a difference.
This desire for control can go into overdrive when we have a sense of economic or political uncertainty. Worried about the situation in North Korea? Concerned that stocks are overvalued? Fearful because first-quarter economic growth was so slow? Suddenly, we’re checking the Dow eight times a day—and listening intently to the competing market outlooks offered on CNBC.
If that’s all we do, there’s no harm. Problem is, this flood of information—and, yes, it’s information, not insight—could prompt us to act. That’s when the trouble begins.
To feel more in control, we might ditch our carefully diversified portfolio and start picking our own investments. We’ll spend hours analyzing stocks, because we’re sure that hard work will improve our performance. Like Wall Street’s notoriously superstitious traders, we’ll adopt quirky daily routines that we associate with better investment results.
We might honestly believe all of this helps our portfolio’s performance: Research suggests we often convince ourselves that the investments we pick on our own perform especially well. This, in turn, further fuels our self-confidence and sense of control. Before long, we could find ourselves making big, undiversified bets and racking up hefty trading costs. But in doing so, we’re sacrificing two things we actually can control: our ability to manage risk and to hold down investment expenses.
The illusion of control isn’t just a danger when investing. If we overestimate how much control we have over our lives, there’s a risk we will skimp on insurance and fail to develop a proper estate plan. We might imagine that we would never do anything that could leave us disabled and that we have plenty of time to get our estate in order—but, of course, we could be making a huge mistake.
How can we avoid the illusion of control? It’s a problem of self-deception, so perhaps we should stop thinking about ourselves—and instead give some thought to how we would advise good friends who aren’t that financially sophisticated. Obviously, we wouldn’t want them calling us up a year from now, complaining that we had led them astray.
So what would we tell them? We know misfortune can strike at any time and that the financial consequences can be devastating, so we would probably encourage them to consider life, disability and umbrella liability insurance, and to make sure they talk to a qualified attorney about their estate.
Meanwhile, we’d tell them to turn off CNBC and stop worrying about the Dow’s daily performance. Instead, we would likely advise them to view market turmoil as an opportunity and to spread their stock market money across a globally diversified mix of low-cost holdings. And we would encourage them to hold some bonds in case of emergency and even more if they’re regularly taking withdrawals from their portfolio.
Which is what we also ought to be doing, right?