It’s tempting to make significant changes to your investment portfolio when the world appears to be changing around you.
But we can learn a lot from medicine when we consider the risks of making changes.
Every time NICE assesses a new drug in the UK, they have a decision to make.
If they don’t approve it, they are potentially saying no to a drug that could help people, and even save lives.
On the other hand, if they do accept it, they could be releasing a drug that does more harm than good.
There are two types of error they could be making:
-A Type I error, or a false positive occurs when NICE approves a drug that either has no benefit or high risk of harmful side effects.
-A Type II error, or a false negative, occurs if a beneficial drug failed to be approved.
If you can only minimize one of these errors, studies suggest that you should focus on avoiding type I errors. Generally, it’s better not to implement a good idea than to implement a bad idea.
The medical research also tells us that someone with a currently untreatable illness is a lot more willing to accept type I errors than someone who has a headache.
The learning from medicine reads across to investments:
-You’d be making a Type I error if you added something to your portfolio which didn’t add a benefit (or which made it worse) – for example if the new addition didn’t reduce risk, increase returns, improve liquidity etc.
-You’d be making a Type II error if you decided against including something that would have benefitted your portfolio.
The medical research says that you should focus on avoiding Type I errors.
It also tells us that you’re more likely to commit a Type II error if you think that your portfolio is suffering from the investment equivalent of an untreatable illness, as opposed to a head cold.
The risk of avoiding a type I error can be minimized by avoiding new ideas – for investments, that means continuing with the conventional approach and investing in a traditional diversified portfolio of shares, fixed interest stock, cash and property.
Before you run the risk of a Type II error, it might just be worth checking whether you are suffering from a terminal illness, or if you are just an investment hypochondriac!
