Banish The Gambler

Investors who follow the herd into get-rich-quick schemes are likely to be losers rather than winners

- Vita Palestrant

Modern economics is based on the assumption that we humans always act in our own best interest and in a purely rational way. But the “irrational exuberance” that led to the 2008 GFC demonstrated just how flawed we are as investors.

Behavioural economist Richard Thaler, winner of the 2017 Nobel Prize for economics, explored these flaws – lack of self-control, limited rationality and routine biases – which give rise to poor choices and embarrassing blunders and leave us baffled in hindsight.

Who can remember the dot.com frenzy, agricultural investment schemes, mass marketing of contracts for difference and forex trading or double gearing into index funds. While they are etched in the memories of those who lost money, they hardly rate a mention now.

Investment fads come and go but they all have common characteristics. They are heavily hyped, create mass followings and convince investors they can make a fortune easily.

Watch for red flags

“How I would define an investment fad is something that was massively popular at the time and not necessarily popular now,” says associate professor Adrian Raftery, the course director of financial planning programs at Deakin Business School. “People invest in them without thinking or knowing much about them. Cryptocurrency is a good example.”

He says an initial $1000 invested in bitcoin shot up to $US20,000 in December 2017 but has subsequently plunged to about $US3200 a year later. (At the time of writing it was about $US7500.) It is also subject to theft. Hackers recently stole $US40 million worth of Bitcoin from one of the largest cryptocurrency exchanges.

“Everyone loves a get-rich-quick scheme – there’s something of a herd mentality about it,” he says. “People will tell everyone about their huge wins but not about their huge losses.”