What is systematic investing? Do we really need systematic investing to stay ahead of the game?
This article discusses the complexities of the investment process and how human biases can lead to suboptimal investment decisions. A systematic investment process can overcome such biases and potentially produce better outcomes for investors. This article was originally presented to a group of high net-worth investors. A video of the presentation can be found here.
This is part 1 of the series, and I’m going to show you how behavioural human biases can lead to suboptimal investment decisions and how important it is to invest systematically.
What is the optimal strategy?
Let’s start with a thought experiment: imagine you have a biased coin — one that has a 51% chance of getting heads and a 49% chance of getting tails. My question is: how much should you invest in each of the thousand coin tosses?
Now, in order to understand this, let’s just rationalise what we could do. Maybe we should invest 100% in each coin toss? Let’s say we have $1000 to start with. So if we invest $1000 in the first coin toss we may win. We now have $2000 and we invest that in the next coin toss and so on.
Well, the problem is that even after a string of heads you will inevitably get to tails, which will wipe you out completely and you will lose everything as it is very unlikely that he would get, say, 1000 heads in a row and win this game completely. We can see that this is not a good idea!
So what about investing a very very small amount of money, say 0.0001%? The problem here is that as you win and lose and win and lose, every time you win a tiny amount of money or you lose a tiny amount of money, but it would take a very very very long time before you actually accumulate anything notable despite the odds being slightly in your favour…
So we know that we have an edge, now what is the optimal strategy?