Why do most people invest incorrectly?
1. People Are Influenced by Society (Herd Behavior)
2. People Are Influenced by Authorities
3. People Are Overconfident
In a classic study (Milgram, 1974), an experimenter asks multiple volunteers to "give" increasingly strong electric shocks to another person in a locked chair in a room next door. In fact, the volunteer is not administering any real electric shock but they think they are. The person (i.e. actor) "receiving" the shocks is unknown to the volunteer administering the electric shocks. The volunteer is told that the individual under research is the one receiving the electric shocks, not them, so their behavior does not change. The jolt levels varied from 75 to 450 volts and were labeled: "slight shock," "moderate shock," "strong shock," "very strong shock," "intense shock," "extreme intensity shock," "Danger: Severe Shock," and a simple but awful "XXX."
After 75 volts, the actor in the other room is trained to start to grunt; complaint at 120 volts; ask to quit at 150 volts; later to beg to stop, and let out agonized screams at 285 volts. After, in complete desperation, the actor is told to yell loudly and talk about heart pain. Later, the actor would not answer any more questions possibly due to a heart attack or even death. If the shocks were real the highest electric levels (three 450 volts shocks) administered by the volunteers would have literally killed the person in the electric chair. A shocking 65% of the volunteers finished the experiment. All volunteers went on go administer shocks of at least 300 volts.
Milgram's experiment is often used to illustrates how a figure of authority - i.e. a professor, expert, or leader - can influence individuals. There is much other empirical evidence of this kind, showing the importance of "authorities" on individual behavior. In finance, individuals are often influenced by authority figures, like parents, to invest in a specific asset, e.g. real estate. Although real estate is a much better investment than leaving large amounts of capital in the checking account, it gives much lower financial returns than a simple total market ETF or index fund. Many parents also say that it is crazy to invest abroad, despite the fact all Nobel laureates and major empirical data says that allocating part of your investment abroad should be a no-brainer.
In summary, authorities are many times right, but they are also often wrong and it is very hard for many people to go against authorities, even when they ask for absurd favors, like in the Milgram experiment. Therefore, it should not be a surprise that investment allocation can be easily influenced by figures of authority, potentially leading to investment portfolios with lower returns and higher risks.
- Milgram, Stanley (1974). Obedience to Authority. New York: Harper and Row.
IMPORTANT: THERE IS NO ONE BEST TAX OR INVESTMENT STRATEGY. IT ALL DEPENDS ON YOUR GOALS, RESOURCES, AND CITIZENSHIP.
For example, are you willing to move abroad? If so, where? How long do want to stay in each place? What is your annual income? How much money are you willing to invest? Do you want short term gains or long-term investments? What is (are) the source(s) of your income? How much taxes do you pay annually? Do you want to decrease your tax duties or completely remove them? Do you feel like you want to pay some taxes even if you do not need to? What is your citizenship? Do you have multiple citizenships? Depending on each of these answers the best investment/tax strategy for you will differ. In order to see what option is best for you and to help with the implementation of the strategy feel free to reach out to us. You do not need to be rich to create a global investment portfolio. Most of the bank and brokerage accounts we open do not have minimum initial deposit or maintenance fee. Thus, you can invest as much as you want or even leave the accounts empty until you have enough capital or interest to invest abroad.