Executive Brief

The behavioural gap: what investors know vs. what they do

Morningstar's Global Head of Behavioural Insights Ryan Murphy on why "simple, but not easy" defines successful investing, how technology amplifies our worst instincts, and why the next edge in behavioural finance lies in designing better choices rather than just naming our biases.

What first drew you to behavioural finance, and what convinced you that investor behaviour deserves as much attention as investment fundamentals?

My academic training is primarily in cognitive psychology and behavioural economics, so it was a natural progression for me to be interested in investments and decision making about money. Markets are, ultimately, massive aggregators of human behaviour and a place where lots of people have goals, aspirations, beliefs, and consider a wide range of alternatives and strategies. It wasn't so much a sudden realisation as it was a natural evolution as a scientist interested in studying how people make important decisions.

After years of studying how investors make decisions, what do you think is the single most damaging behavioural mistake investors continue to make? What makes it so difficult to overcome?

If I had to identify one thing, I think it comes down to: fiddling. Many people have a persistent tendency to try and time the market and tinker with their portfolios. The evidence from behavioural finance is overwhelmingly clear; the more people mess around with their portfolios and try to time the market, the worse they do in aggregate. Wealth creation relies on having a sufficient savings/investment rate and letting a returns process compound over time, but the urge to "do something" actively interferes with that process and undermines wealth accumulation.

Many investors understand the principles of long-term investing, diversification and discipline, yet still struggle to follow them. Why is the gap between knowing and doing so persistent?

Warren Buffett famously said that good investing is “simple, but not easy”. The gap exists precisely in that "not easy" part. Being an investor is hard and that is worth recognising. Our brains are not wired for the behaviours generally required to be a successful investor. Investing requires (1) patience and the ability to (2) endure irreducible uncertainty (neither of these things come naturally to people). Furthermore, these cognitive shortcomings are exacerbated by modern technology and apps that demand/steal our attention, and then provide quick dopamine hits for potentially bad investing choices (i.e. excessively checking performance, returns chasing, and even day trading).

What have major events over the past decade taught you about how investors really respond to uncertainty?

While the pandemic and major geopolitical shifts dominate the headlines, the most consequential shift I've observed is the pervasive rise of mobile technology. The smartphone has made investing potentially lightning-fast and even a source of entertainment. While technology can be wonderful, in this context, it often just allows people to make bad decisions faster. The emergence of crypto and meme stocks, amplified by these tech platforms, makes speculation exciting and obscures what real, long-term investing is actually about. Again, echoing Buffett, long-term investing when done right turns out to be rather boring.

Markets often become captivated by compelling stories, whether it's AI, crypto, meme stocks or whatever the next big disruption may be. How should investors distinguish between a great story and a great investment opportunity?

I think the harsh truth is that there is no simple way for most people to make that distinction, which is exactly why humility is such a vital feature when it comes to good investment decision-making. We diversify our portfolios precisely because we recognise we cannot perfectly predict the future; diversification is an expression of that humility. Flashy, attention-grabbing headlines are abundant, but they are a dubious source of information for long-term portfolio construction. Instead of trying to develop a magic crystal ball to discern a great story from a great investment, I would suggest investors should step back, buy broadly diversified investments across a wide range of asset classes, give themselves enough time to benefit from full market cycles, and then let the engines of modern capital markets evolve without trying to time the market (or try to distinguish among all the great stories out there).

What role do you see AI playing in how investors behave going forward? Will it help them make better decisions or simply make it easier to act on existing biases?

I worry more about the latter. AI is, at least so far as I can tell, not a tool to help people become deep experts and critical thinkers. There is a massive difference between deep expertise and the superficial, good-sounding answers that AI can easily generate. Experts can perceive that gap whereas non-experts generally cannot. Moreover, we know people tend to fall for the confirmation bias—looking for information that supports existing beliefs they already have. AI can amplify this (and tell people how smart they are in the process…). Current AI tools play to this. We know from decades of published research what behaviours lead to long-term investing success. If decision support systems can encourage people to save more, diversify their investments, avoid overly concentrated positions, and stay in the market for full cycles, it will be a net positive. But there are many other applications of AI that may simply lead people astray.

If you could convince investors to adopt just one habit that would materially improve their financial outcomes over the next decade, what would it be and why?

The defining characteristic of successful investors, and the single habit I would urge everyone to adopt, is this: save and invest an adequate amount every month, invest it in a well-constructed, highly diversified long-term strategy, and then leave it alone. You have to give yourself the benefit of full market cycles to allow your wealth to compound. The habit is discipline through inaction. Trying to time the market is almost never rewarded for most investors, so the best thing you can do is map out how to get from where you are to where you want to go, and stop fiddling with the engine along the way.

Looking ahead, what area of behavioural finance do you think remains most misunderstood today, and where do you expect the next wave of research to focus?

Much of behavioural science over the past few decades has successfully highlighted the persistent biases and irrationalities human decision-makers suffer from. This is a fascinating line of work. However, merely finding and pointing out peoples' cognitive biases doesn't necessarily help them make better decisions. For me, the most promising frontier now goes under the term "choice architecture." This is the recognition that we can help imperfect decision-makers by mindfully and better constructing the contexts in which they make choices. Instead of just identifying the mistakes people make, we can actively design environments and ask questions in ways that help them avoid those predictable errors.

What books, podcasts, or ideas have most influenced the way you think about decision-making and human behaviour?

I highly recommend Nudge by Richard Thaler and Cass Sunstein. It provides a phenomenal framework for thinking about choice architecture, offering brilliant examples of how it can be applied across various fields. I also consider Thinking, Fast and Slow by Daniel Kahneman to be required reading. Kahneman won the Nobel Prize in Economics in 2002, and it is remarkable that he and his co-author, Amos Tversky, both psychologists, produced some of the most cited articles in all of economics. Their work highlights the importance of understanding the psychology of decision-making, and how we can use that understanding to help normal people, with all their foibles, make better decisions in high-consequence environments like finance.