Imagine you're piloting a plane coming in for a landing at the end of a long flight. You're on autopilot because of dense fog enshrouding the runway but everything is going smoothly. You're descending to 500 feet, 400 feet ... You start thinking about how you'll be able to take a break and spend some nice time with your family. What will everyone want to do? Go for a hike? Have some friends over to grill out back? Or just take it easy and decide later?
Suddenly, at 50 feet, the plane points steeply towards the ground. With only four seconds to touchdown, you immediately grab the control column and pull back to avert a nosedive onto the runway. Your landing is rough, but you avoid a complete disaster.
This incident actually happened with a Boeing 747 traveling from Miami to London in 2000. It was documented in the book How We Decide by Jonah Lehrer for its lessons on decision making. It can just as easily serve as an instruction manual for investors lulled by an extended period of low volatility.
Investors might be forgiven for being less than completely vigilant. After all, it's been three years since the market has experienced a correction in the summer of 2011. We all have other things to do. In fact, Lehrer notes this is exactly how most people envision autopilot: "People who aren't pilots tend to think that when the autopilot is on, the pilot can just take a nap".
Just because market volatility has been low for an extended period of time doesn’t mean you can be cavalier about your investments. As Lehrer reports, "You can't ever relax in the cockpit." In the case of the fated flight in 2000, it was a software glitch that caused the problem. But it could have been anything. Investing, like flying, is a complicated undertaking and as such it requires ongoing attention. Problems can arise from anywhere and at any time, including at the worst possible time.
Despite several efforts to improve airline safety between 1940 and 1990, Lehrer notes that the percentage of plane crashes due to pilot error remained remarkably steady. Error rates finally declined dramatically with the advent of realistic flight simulators. "The benefit of a flight simulator,” Lehrer explains, "is that it allows pilots to internalize their new knowledge. Instead of memorizing lessons, a pilot can train the emotional brain, preparing the parts of the cortex that will actually make the decision when up in the air.”
Investing too can evoke significant emotional responses which can override cognitive responses and lead to poor decision making. Investors can replicate the experience of flight simulators by being fully aware of possible investment hazards, by familiarizing themselves with what tough situations “feel” like, and by developing constructive responses that can be invoked easily in a time of need.
Prior to the 1970s, Lehrer tells us, "many cockpit mistakes were attributable, at least in part, to the ‘God-like certainty’ of the pilot in command.” Research revealed that important mistakes were often made due to unusual arrogance on the part of a leader and to unusual deference on the part of other team members. In response, an alternative decision making strategy was designed (Cockpit Resource Management, or CRM) to "create an environment in which a diversity of viewpoints was freely shared."
The main lesson for investors from these developments is to not place too much credence in any one person's opinion. While wealth advisors and money managers may very well be more attuned to various financial market news, they are human too and can get distracted and make mistakes. It behooves everyone involved to pay attention and to ask questions if things don't make sense.
While the autopilot technology and pilot training have both improved substantially, neither is perfect all the time. As in the example of the Miami to London flight in 2000, the autopilot worked beautifully until it didn't. Fortunately the pilots were paying attention and reacted immediately and appropriately. As Lehrer determines, "the real reason planes are so safe, even though both the pilot and the autopilot are fallible, is that both systems are constantly working to correct each other."
While many investors would prefer to remain completely uninvolved in the management of their investments, such a course presents multiple opportunities for mistakes to be made. There are good people and good systems that can help, but just like with autopilot, each can fail. You can vastly improve your chances of investment success by keeping an eye on things to make sure they are all working properly.
Much like flying a commercial airline is inherently a complicated exercise fraught with risks, so too is investing. Also, much like some of the biggest and most avoidable mistakes with flying occur because of human error, so too does human error figure prominently in investment mistakes. Fortunately, great lessons and insights about decision making can significantly improve the outcomes of both activities. Investors who pay attention and ask questions, even during these lulls, stand a much better chance of avoiding trouble.
Best wishes for a safe landing!