Navigating behavioural biases, market volatility, uncertainty in investment journey

Soros explained these ideas succinctly: “I can state the core idea in two relatively simple propositions. One is that in situations that have thinking participants, the participants’ view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. That is the principle of reflexivity.” 

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He further noted that financial markets often exhibit self-reinforcing, but eventually self-defeating, boom-bust cycles, a phenomenon observable in other areas as well.

Soros’s philosophy—a blend of financial returns, personal experience, and economic theory—proved invaluable during the 2008 financial crisis. His insights remain relevant today, particularly as we find ourselves navigating a Global Election Supercycle amid rapid and unpredictable market movements.

Political and economic shifts, from India’s election results to the attempted assassination of Donald Trump and Joe Biden’s withdrawal from the US election, are compounded by fluctuating currencies and the rally of US small-midcaps versus the Magnificent 7. This unpredictability begs the question: Can we forecast market movements? 

The short answer is no—we cannot predict the market with certainty. Market movements fall under the category of unknown unknowns. Financial markets are influenced by a myriad of interdependent variables, making it nearly impossible to isolate the effect of any one factor. The complex interplay of market forces, human behaviour, and external shocks renders predictions uncertain and inherently unpredictable.

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However, while we may not forecast the future with precision, we can still prepare for it. Two approaches are essential: qualitative and quantitative. Each method offers unique insights, and together, they help investors manage financial market uncertainties.

Planning for uncertainty

Quantitative Approach:

In volatile times, protecting capital becomes more crucial than maximizing returns. This may involve maintaining a larger cash buffer, purchasing insurance, or hedging against unforeseen events. Avoiding FOMO (fear of missing out) is critical but challenging. An investment plan should align with an individual’s risk tolerance, whether conservative, moderate, balanced, or aggressive, with corresponding asset allocations.

Qualitative/Behavioural Approach:

Understanding human biases is key when evaluating investment decisions. Biases can be classified into two categories:

Cognitive errors: These include conservatism, confirmation bias, representativeness, illusion of control, hindsight bias, anchoring, and mental accounting.

Emotional biases: Examples include loss aversion, overconfidence, self-control, status quo bias, endowment effect, and regret aversion.

These biases are deeply ingrained in human psychology, often operating unconsciously. Cognitive errors, like reliance on heuristics, may be hard to recognize, while emotional biases can override rational thought. Psychological resistance, such as cognitive dissonance and confirmation bias, further complicates decision-making by encouraging us to reject information that contradicts our beliefs.

These biases are deeply ingrained in human psychology, often operating unconsciously. Cognitive errors, like reliance on heuristics, may be hard to recognize, while emotional biases can override rational thought. Psychological resistance, such as cognitive dissonance and confirmation bias, further complicates decision-making by encouraging us to reject information that contradicts our beliefs.

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Just as it’s nearly impossible to perfectly time the market, it’s equally difficult to control these biases. The best defence is an all-weather portfolio, diversified across traditional assets (equities, fixed income), inflation-hedging assets (commodities), and aspirational investments (venture capital, private equity, hedge funds, venture debt, and performing credit).

As financial markets experience increasingly frequent and volatile boom-bust cycles, investors must remain flexible and open to new information, echoing John Maynard Keynes’s famous sentiment: “When the facts change, I change my mind—what do you do, sir?”

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This mindset is crucial not only in finance but in life. Events beyond our control will challenge our predictions and behaviours. Our emotions and biases inevitably colour our decisions, sometimes at the expense of acknowledging the facts. By embracing uncertainty, staying disciplined, and maintaining flexibility, we can better navigate an unpredictable world.

Prashant Tandon, senior director, listed investments, Waterfield Advisors.