The S&P / ASX 200 was up 0.7% in early morning trade as markets put the worry about the Ukraine and increasing tensions between Russia and the U.S. aside. Despite being up 5% since the year low on February 5, year to date the ASX is as flat as a pancake.
So far this year we've had worries over crashing iron ore and copper prices, euphoria over a rising gold price, concerns over China's shadow banking system, and one missing plane.
Like you, I'm glued to the latest on the disappearance of Malaysian Airlines flight 370, and the host of conspiracy theories trying to explain the mystery. I'm confident, in time, it will be solved. I'm even more confident that, in an even shorter period of time, the story will move off the front pages and the tragedy will be largely forgotten… except of course for the friends and families of the passengers and crew.
Below, Motley Fool colleague Morgan Housel has more on this, and specifically how most people are hopeless at assessing risk. Humans often assume the worst can and will happen. That is perfectly illustrated as the iron ore price crashed more than 20% from over US$130 a tonne to below US$110 a tonne. Investment bank Goldman Sachs then came out predicting iron ore will average US$80 a tonne in 2015.
Iron ore miners Fortescue Metals Group Limited (ASX: FMG) and Rio Tinto Limited (ASX: RIO) sank 17% and 12% respectively, no doubt as many shareholders sold out assuming Goldman Sachs prediction to be fact. Maybe investors need to take a more optimistic view, as Monty Python put it best in the movie Life of Brian, "Always look on the bright side of life".
Anyway, here's Morgan with his view on why we're hopeless at assessing risk. Enjoy.
Why we're awful at assessing risk
By Morgan Housel
Like most of you, I've been glued to news of the missing (as of this writing) Malaysian Airways jet for the last ten days. It's a gripping story. Mixing tragedy with mystery is impossible to ignore. For the families of the missing, this is a terrible ordeal. For the rest of us, there's something strange about how we cover events like the missing plane in the news.
Flight 370 disappeared on Saturday 15th March with 239 people aboard.
Using annual averages, in the week that followed, 10,500 people around the world have likely died from malaria since then. 4,000 have died from traumatic injuries, and 16,500 from tuberculosis. In America alone, 9,900 people have died of heart disease since Saturday, 600 have died in car accidents, while 250 were likely murdered. Yet virtually none of these stories have made the news anywhere in the world, nor generating anywhere near the attention that Flight 370 has.
Most of us have a flaw when reacting to risk: Threats like plane crashes, which are statistically insignificant but rare, grab our attention and scare us more than those that are deadly serious but common, like heart attacks and car accidents.
The gap between the things we worry could happen and what's actually happening around us can be huge. Some estimate that as many as 20,000 Chinese coal miners die each year, nearly all without a word from the media. But if just one person died in a nuclear power accident, it would be global news for decades. If the Australian news focused on the biggest threats we face, it'd write about almost nothing other than poor diet, lack of exercise and mental health — which are probably three of the least covered topics.
Coming to terms with the fact that nearly all of us are bad at assessing risk is vital to managing money. This is especially true because money is emotional, taboo, and many of us are financially illiterate and borderline innumerate. Paul Slovic runs the Decision Research Institute in Oregon. He's spent his career studying how people judge risk. Slovic's research shows that people overestimate risk when a danger has a handful of qualities, including:
- Catastrophic potential: Lots of people affected at once, rather than in small numbers over time.
- Familiarity: A risk that isn't common knowledge.
- Understanding: A sense that something isn't well understood by experts.
- Personal control: A sense that danger is outside your control.
- Voluntariness: Something can do harm even when you don't voluntarily put yourself in danger.
- Children: Mention the word children, and panic multiplies.
- Victim identity: As Joseph Stalin said: "One death is a tragedy; one million deaths is a statistic."
- Origin: Man-made risks are viewed as more dangerous than natural disasters.
You can imagine how these fit into finance. People dread a big market crash because it affects everyone at once, but pay little attention to our low discretionary savings rate of around 2%, which ruins individual people's financial lives slowly over time.
We panicked over the flash crash in 2010, not because it was a big deal, but because it was a new, mysterious risk that we knew little about. And when you hear anecdotal stories about individuals fleeing the stock market in 2008, it sounds much more distressing than the reality of 97% of investors not fleeing the market in 2008. In all of these cases, people focus on the wrong risks — or overestimate risk and damage happening around them — which leads to overreaction at the worst possible time.
The best example of this comes from German professor Gerd Gigerenzer, who showed that the increase in car travel stemming from people's fear of air travel directly after 9/11 likely led to an increase in traffic fatalities measured in the thousands, and possibly more than the number of actual 9/11 victims. There's hindsight bias in that observation, but obsessing about a small risk while ignoring a much larger one is par for the course in human behaviour. "People jump from the frying pan into the fire," Gigerenzer wrote.
In investing, high-profile risks that we talk about all the time, like whether stocks are going to fall next month or whether a company is going to miss quarterly earnings, aren't nearly as dangerous as the slow-burning risks we habitually ignore. Take these three.
1. Fees
Vanguard shows that if your investments earn a 6% annual return, a 1% management fee will reduce your account balance by half over 50 years. I can't imagine how many investors would shriek at a possible (and temporary) 50% market crash, but don't bat an eye at a fee that will guarantee them the same result with no chance of recovery.
2. Trading too much
Investors who do the least will likely do the best over time. For the huge majority of people, investing a set amount of money each month consistently over a long period of time will outperform any trading strategy they attempt.
The evidence on this is overwhelming. It's so overwhelming that I think the single biggest risk you face as an investor is that you'll try to be a trader. It's the financial equivalent of drunk driving — recklessness blinded by false confidence. "Benign neglect, bordering on sloth, remains the hallmark of our investment process," Warren Buffett once said. It probably should be yours, too.
3. Not saving enough
The personal savings rate is currently about 10%, which is around its long-term average, but that may be somewhat illusory, given it includes compulsory superannuation.
According to a recent study by Credit Suisse research analyst Damien Boey, removing super lowers the discretionary savings rate to just 2%. That statistic poses a way bigger risk to people's finances than the numbers that get thrown around showing how overvalued the stock market is.
Most people spend too much time trying to become a better investor and not enough time trying to save more money. That's especially true if you're young. As the saying goes, "Save a little bit of money each month, and at the end of the year, you'll be surprised at how little you still have." More financial misery has been caused by ignoring these three risks than has in nearly all the irrelevant risks the investment media writes about all day long. Not realising this is why most of us are bad at assessing risk.
