For several years in the early 2000s, Rudy Kurniawan was a well-known wine collector and dealer. He specialised in rare and valuable wines, particularly Burgundy and Bordeaux, and became a multi-millionaire. Wealthy people relied on him to guide them toward the most delectable wines.
The problem was that Kurniawan was a fraudster. (1) He was actually selling cheap red wine with fancy-looking labels. He was found guilty on multiple charges in 2014 and sent to prison.
So how did he manage to get away with it for so long? How did he manage to fool so many people? Even top wine connoisseurs believed his wine was exquisite.
The reason is simple: human beings have a powerful confirmation bias. In other words, we tend to see or hear what we expect to encounter.
When Kurniawan invited sommeliers to try his wine, he told them they were about to taste a highly sought-after vintage worth thousands of pounds a bottle. Their taste buds were primed to taste something exceptional – and so they did.
The story of Rudy Kurniawan should serve as a cautionary tale to investors when looking for a fund to invest in.
To be clear, I’m certainly not saying that people who sell market investment funds are crooks and charlatans in the same way as Kurniawan was. But the fund industry is acutely aware of our behavioural biases, and confirmation bias in particular.
We’re not as rational as we think
Most of us like to think that we’re rational creatures who make calm, considered investment decisions, but it simply isn’t true. Money and the financial markets evoke strong feelings in people. At a very basic level, those feelings include fear and greed. We can be haunted by memories of losing money, and we can fantasise about suddenly becoming rich.
Whatever those feelings might be, fund industry marketing departments know just the right buttons to press to make us sit up and take notice.
So, for example, they will try to convince us that a particular fund will keep our money safe if markets fall; or that a fund will deliver outstanding returns. (2) Sometimes they try to imply that a fund will produce what they call an absolute return regardless of market conditions, even though it hardly ever happens. (3)
They also know that we like the idea of having someone very clever managing our money for us, so they will point us towards a “star” fund manager. (4) Alas, most star managers eventually fall to earth.
Expensive doesn’t mean high quality
Another trick that marketers use is to make a fund seem “reassuringly expensive”. With most products and services, the more you pay, the higher the quality you can expect. But it doesn’t always work like that. Studies have shown, for example, that expensive, brand-name painkillers are rated as much more effective than their generic counterparts, and yet the composition of the pills is identical. (5)
The same applies to people’s perceptions of funds. We assume that because one fund is more expensive than another, or has a more recognisable brand name, it must be superior. But the evidence shows us, time and again, that most investors are better off investing in plain vanilla index funds which are almost invariably cheaper than their actively managed counterparts.
Unfortunately, modern communications have made it even easier for marketers to exploit our confirmation bias.
For example, internet search engines and social media platforms personalise search results and news feeds based on user preferences. This can create "filter bubbles”, where individuals are exposed only to information that confirms their existing beliefs.
How to combat confirmation bias
It’s crucially important, then, that investors guard against confirmation bias, particularly in relation to industry marketing. As with all behavioural biases, it’s tough to eradicate them altogether, but here are some strategies you could implement to reduce their negative impact.
- Acknowledge the problem. The first step is to recognise that confirmation bias exists and can influence your decision-making. Acknowledging this bias is crucial to addressing it.
- Use other sources. Actively seek out information from a wide range of sources, including those that may present differing viewpoints and opinions. Avoid relying solely on sources that align with your existing beliefs.
- Play devil’s advocate. Challenge your own assumptions and beliefs by actively seeking out counter-arguments and opposing viewpoints.
- Seek advice. Talk to a trusted financial adviser or mentor who can offer alternative perspectives. Be open to constructive criticism and differing viewpoints.
- Follow a structured process. Develop a checklist or decision-making frameworks that outline your criteria for making investment decisions.
- Stay mindful. Practise mindfulness and emotional control techniques to manage emotional reactions to market events, which can trigger confirmation bias.
- Keep learning. Continuously educate yourself about behavioural finance. Understanding the psychological factors that influence decision-making can help you become more aware of them.
The funds you need may never be marketed
One last thing. Bear in mind that fund management companies spend an absolute fortune on marketing. For example, they pay for full-page adverts in national newspapers and to sponsor prestigious sporting events. They also provide the advertising revenue without which most financial media outlets wouldn’t even exist.
The overriding impression this marketing effort creates is one of quality and reliability. But the fact is that, in the long run, very few funds outperform simple, plain vanilla index funds on a properly cost- and risk-adjusted basis. And index funds are hardly ever promoted. Why? Because the industry generates bigger profits by selling more expensive funds.
Remember: the voice with nothing to sell can be hard to hear. (6)
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
Robin Powell is a journalist, author and editor of The Evidence-Based Investor.
References:
- https://en.wikipedia.org/wiki/Rudy_Kurniawan
- https://youtu.be/Gc2ZVmLjlCs?si=1dE54dQcPKRsuKMF
- https://youtu.be/34N_by0ejhU?si=gkvEwoTAhLlFuFzx
- https://youtu.be/8erIP0b3Euk?si=w6q4-hYf5Jg29Xqj
- https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6415809/
- https://www.moneymarketing.co.uk/opinion/robin-powell-the-voice-with-nothing-to-sell-is-hardest-to-hear/
