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COVID, control and risk

Strangely, investors often worry about things that they cannot control. But they ignore the things that they can actually control

COVID, control and risk

COVID, economic recovery, corporate creditworthiness, interest rates, etc., etc. Shouldn't you, as an investor, be worried about these things?

However, if you think about it, isn't it strange that investors worry about things that they cannot control, while ignoring the things that they actually can? Can you influence the progression of COVID? No, you can't. Can you control which mutual funds you will invest in and when? Of course, you can. So, which one should take more of your thinking time?

Some years ago, I read an interesting article by an American security expert named Bruce Schneier. Schneier is a cryptographer and computer security specialist who has evolved into a thinker and writer about all kinds of risks and security. Some of his ideas about the risk and human reactions to it have great relevance to investing.

The concept I read about has to do with something he calls 'Control Bias'. Essentially, he says that we tend to underestimate risks in situations where we are in control and overestimate risks in situations when we are not in control. The most common example he gives is the fear of flying vs the perception of risk while driving. There's clear evidence that flying in a commercial airliner is by far the safest mode of transport. In contrast, Indian roads are quite unsafe. Yet, many sensible people have a deep fear of flying but are quite unconcerned about driving. In fact, the fear of COVID interacts with risks that we choose to take in strange ways. The other day, my car was almost hit by a motorcyclist who was driving fast on the wrong side and that, too, without wearing a helmet. However, he was wearing a proper mask! He had chosen to stay safe from COVID while taking far greater risks by his other actions.

People take slippage in risk levels unthinkingly. They chat or type on their phones while driving and even two-wheeler riders are WhatsApping while driving. Yet, they are scared of flying. All these could be examples of Control Bias. When we are doing something ourselves, we have an illusion of control. We underestimate risk because we are in possession of all the facts and we feel that we can control the situation when in reality we can't. When flying, we really don't know what's happening so we do not have the illusion of control.

I find that this illusion of control is exactly what makes people underestimate risk while investing. It is a fact that most people don't know enough to be investing without any advice. Yet they do so because they have a large amount of information that makes them believe that they know enough to be in control of the situation. Someone sells investors a story about why the investment will do well and the story appears to have enough information to give an adequate illusion of control.

This is also the reason why many genuinely knowledgeable equity investors advise newcomers against investing in mutual funds. These people have enough information about stocks but feel inadequately informed about what is going on with their money in a mutual fund. The mutual fund investment manager is like the pilot and you don't know what he's doing on the flight deck.

Unfortunately, investing also has its equivalent of driving drunk or without good brakes and tyres. Very few investors follow any systematic risk control in their portfolio. They don't diversify properly and they don't track exactly what is happening with the investments they have already bought. The fact that they are doing things themselves gives them the illusion that they know what's happening and if the situation gets tricky, they'll manage to get out of it.

This editorial appeared in Mutual Fund Insight June 2021 issue. To read the cover story and other insightful analyses, columns and articles

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