FOOL'S EYE VIEW
Illogical Investment

By Stephen Bland (TMFPyad)
January 29, 2001

Peoples' priorities are funny. I mean funny peculiar, not funny ha-ha.

I am referring specifically, since this is the Motley Fool, to financial priorities and the way that many will go about selecting investments, the consideration of risk and emotional values involved.

For a large part of the population who are prepared to stick a lot of money into anything at all, the purchase of a property is likely to be their main investment. As we all know this is not normally done for the primary reason of investment as such but for the purpose of having a place to live. Traditionally in this country we buy rather than rent and thus a great deal of care will usually be put into finding a suitable place. So far so logical.

Similarly, those buying cars will frequently exercise a fair degree of personal taste and judgement in the matter rather than walking into the first dealer and buying the first car they see. Again, wholly logical.

I am not here, though, to put the case for humans being wholly logical, financially at least. For a start I wouldn't be able to make much through my own personal investment strategy of value if people were completely logical about shares. But I just wanted to start off the article with some examples of where they are so. Where it starts to go wrong is with investing, whether in shares, funds or insurance company savings and pension plans, to quote some typical examples.

Almost nobody, when considering investing money, even sums that may be quite substantial over long periods, will devote the kind of care to doing so that they might when buying a house or car: a situation which we at TMF exist to rectify for our readers.

Many times around TMF people have published illustrations of the appalling performance of some insurance company savings or pension plans after long periods. I have shown examples of the latter myself on the pensions board. Yet investors still buy these things without comparing the merits of various plans, without considering various funds that can be chosen in which to invest a pension plan for example.

In my business life, I see a lot of people with various kinds of long term savings plans, usually pensions taken out by self-employed clients. If I ask them why they chose a particular insurance company, or a particular fund or funds in which the plan is invested, then nearly always they have no reasoned answer. Hardly anybody, out of large numbers of people, will be able to say that they spent time researching the matter before deciding which plan to go for.

Often, for example, a person may have some general insurance for their house with a company and a salesman from the same company may then have successfully sold them a pension or savings product. The only reason they bought was because the same company may have been insuring their house. Another common point of sale is the building society or bank. These companies are always trying to market pensions and savings plans to their customers as ways of extracting more profit from them. In many cases they will be successful. No matter how appalling the product, the customer will very often buy without any kind of evaluation whatsoever simply because they were there: lambs to the slaughter.

We all know this I guess. No revelations here and maybe TMF can redress the balance to as great an extent as possible. But I know that this still goes on in vast numbers.

The question is why? Why do people commit monthly savings that will add up to substantial amounts over time, or lump sums even, without giving the matter the slightest consideration or comparison in the way they would when buying a house or car? Why are people so often irrational when it comes to investing money?

I can see two areas that may attempt to answer these questions.

Firstly, the product is invisible. Investing in a long term savings/pension plan does not give you something immediate and tangible to utilise or enjoy in the way that a house, car, furniture etc. obviously does. Ultimately the performance of that pension plan may be critical to your financial well-being, but that is likely for many to be a long way off. It has no immediacy and you cannot get any pleasure or use out of it at the outset.

Secondly, the whole subject of long-term investment and pensions is uninteresting and overly complex for large numbers of people. Surprisingly, this is the case even though they are prepared to devote substantial sums towards it. People will take out pensions because of some vague belief that they ought to have one. But that is about as far as it goes for the majority, it seems to me. Actually devoting some energy to comparing different investment strategies, including alternatives to pension plans, appears to be beyond all but the most dedicated investors.

So as a result a certain laziness has developed that enables cynical salespeople to exploit the lack of interest or comprehension by large numbers of the investing population and sell them, frankly, junk. Investment consumers do not in the main exercise any critical faculties at all but buy the first thing they are offered, or perhaps see in an ad.

This works only with investments. It could not happen in the house, car or furniture business. Taking pensions as an example, because poorly performing products are endemic in this industry. Imagine if the standard of the car industry was on a par with that of the pensions industry. The equivalence would be where maybe the majority of all cars on the road were rubbish, suffering constant breakdown and so on. Yet modern cars are amazingly reliable and a company that regularly churned out second-rate cars could not remain in business because consumers would not buy.

But that does not happen with the insurance and investment industry. Companies with poor investment products will often thrive precisely because consumers suspend their critical faculties. They continue to buy junk. What other industry could continue to exist like this?

And thus the financial illogicality of the large part of the investing public is demonstrated. It is a very hard battle to change this.

Where Next?

Pensions discussion board
Investment Psychology discussion board