Details Are Part of Our Difference
Embracing the Evidence at Anheuser-Busch – Mid 1980s
529 Best Practices
David Booth on How to Choose an Advisor
The One Minute Audio Clip You Need to Hear
Category: Education
Investment Lessons from Buffett’s Brave Bet
When I joined Hill Investment Group in 2015, I was still relatively new to evidence-based investing, which meant I needed a lot of flexibility as I too experienced a learning curve around the science of investing. Fortunately, a few meaningful messages went a long way toward helping me Take the Long View®. Warren Buffett’s 10-year bet against hedge funds was one such lesson that immediately made sense to me. Like some of my favorite yoga poses, or “asanas,” it has a lot to do with discovering the right perspective. (Yes, that really is me, practicing how to bend over backwards for our clients!)
Back in January 2008, Buffett made a substantial charitable wager in favor of index investing. He bet that, after ten years ending December 31, 2017, a low-cost S&P 500 index fund could outperform any selection of at least five hedge funds his competitor selected, net of fees. That’s how strongly Buffett believed in the power of keeping it simple and controlling costs – just like we emphasize here at HIG.
Buffett ended up so far ahead in the wager that his opponent graciously admitted defeat last May, months ahead of the year-end deadline. His example helped me further embrace the benefits of calm, purposeful evidence-based investing. It’s not only a less stressful way to go, it’s typically a rewarding way as well. Way to go, Warren!
Behavioral Biases: Symptoms and the Financial Damage Done
Congratulations to University of Chicago’s Richard Thaler for his recent Nobel Prize in economics! This isn’t the first time we’ve mentioned Professor Thaler. I referenced his work last year. And here, Rick Hill shared a conversation between Professor Thaler and fellow Nobel Laureate and University of Chicago colleague Eugene Fama. Thaler also is well known for his groundbreaking book, Nudge: Improving Decisions About Health, Wealth, and Happiness.”
Why do we keep mentioning the guy, and why does the Nobel committee agree that his work is worth recognizing? I can’t speak for the Nobel committee, but I can say that understanding Thaler’s many contributions to behavioral economics is essential to anyone who wants to Take the Long View® with their wealth. Just as financial economics focuses on how to best manage the market’s idiosyncrasies, behavioral economics focuses on how to curb our own behavioral biases, which often pose the greatest threat to our financial well-being.
When it comes to defending against your behavioral biases, forewarned is forearmed, so here’s a summary of some of our most damaging, if all-too-human traits.
The Bias: Anchoring
- Symptoms: Anchors aweigh! It’s easy for us to fixate and base ongoing decisions on an initial piece of information (the “anchor”), even if it’s no longer relevant to the decision at hand.
- Damage Done: “I paid $11/share for this stock and now it’s only worth $9. I won’t sell it until I’ve broken even.”
The Bias: Blind Spot
- Symptoms: The mirror might lie after all. We can assess others’ behavioral biases, but we often remain blind to our own.
- Damage Done: “We are often confident even when we are wrong, and an objective observer is more likely to detect our errors than we are.” (Daniel Kahneman)
The Bias: Confirmation
- Symptoms: This “I thought so” bias causes you to seek news that supports your beliefs and ignore conflicting evidence.
- Damage Done: After forming initial reactions, we’ll ignore new facts and find false affirmations to justify our chosen course … even if it would be in our best financial interest to consider a change.
The Bias: Familiarity
- Symptoms: Familiarity breeds complacency. We forget that “familiar” doesn’t always mean “safer” or “better.”
- Damage Done: By overconcentrating in familiar assets (domestic vs. foreign, or a company stock) you decrease global diversification and increase your exposure to unnecessary market risks.
The Bias: Fear
- Symptoms: Financial fear is that “Get me out, NOW” panic we feel whenever the markets turn brutal.
- Damage Done: “We’d never buy a shirt for full price then be O.K. returning it in exchange for the sale price. ‘Scary’ markets convince people this unequal exchange makes sense.” (Carl Richards)
The Bias: Framing
- Symptoms: Six of one or half a dozen of another? Different ways of considering the same information can lead to illogically different conclusions.
- Damage Done: Narrow framing can trick you into chasing or fleeing individual holdings, instead of managing everything you hold within the greater framework of your total portfolio.
The Bias: Greed
- Symptoms: Excitement is an investor’s enemy (to paraphrase Warren Buffett.)
- Damage Done: You can get burned in high-flying markets if you forget what really counts: managing risks, controlling costs, and sticking to plan.
The Bias: Herd Mentality
- Symptoms: “If everyone jumped off a bridge …” Your mother was right. Even if “everyone is doing it,” that doesn’t mean you should.
- Damage Done: Herd mentality intensifies our greedy or fearful financial reactions to the random events that generated the excitement to begin with.
The Bias: Hindsight
- Symptoms: “I knew it all along” (even if you didn’t). When your hindsight isn’t 20/20, your brain may subtly shift it until it is.
- Damage Done: If you trust your “gut” instead of a disciplined investment strategy, you may be hitching your financial future to a skewed view of the past.
The Bias: Loss Aversion
- Symptoms: No pain is even better than a gain. We humans are hardwired to abhor losing even more than we crave winning.
- Damage Done: Loss aversion causes investors to try to dodge bear markets, despite overwhelming evidence that market timing is more likely to increase costs and decrease expected returns.
The Bias: Mental Accounting
- Symptoms: Not all money is created equal. Mental accounting assigns different values to different dollars – such as inherited assets vs. lottery wins.
- Damage Done: Reluctant to sell an inherited holding? Want to blow a windfall as “fun money”? Mental accounting can play against you if you let it overrule your best financial interests.
The Bias: Outcome
- Symptoms: Luck or skill? Even when an outcome is just random luck, your biased brain still may attribute it to special skills.
- Damage Done: If you misattribute good or bad investment outcomes to a foresight you couldn’t possibly have had, it imperils your ability to remain an objective investor for the long haul.
The Bias: Overconfidence
- Symptoms: A “Lake Wobegon effect,” overconfidence creates a statistical impossibility: Everyone thinks they’re above average.
- Damage Done: Overconfidence puffs up your belief that you’ve got the rare luck or skill required to consistently “beat” the market, instead of patiently participating in its long-term returns.
The Bias: Pattern Recognition
- Symptoms: Looks can deceive. Our survival instincts strongly bias us toward finding predictive patterns, even in a random series.
- Damage Done: By being predisposed to mistake random market runs as reliable patterns, investors are often left chasing expensive mirages.
The Bias: Recency
- Symptoms: Out of sight, out of mind. We tend to let recent events most heavily influence us, even for our long-range planning.
- Damage Done: If you chase or flee the market’s most recent returns, you’ll end up piling into high-priced hot holdings and selling low during the downturns.
The Bias: Sunk Cost Fallacy
- Symptoms: Throwing good money after bad. It’s harder to lose something if you’ve already invested time, energy or money into it.
- Damage Done: Sunk cost fallacy can stop you from selling a holding at a loss, even when it is otherwise the right thing to do for your total portfolio.
The Bias: Tracking Error Regret
- Symptoms: Shoulda, coulda, woulda. Tracking error regret happens when you compare yourself to external standards and wish you were more like them.
- Damage Done: It can be deeply damaging to your investment returns if you compare your own performance against apples-to-oranges measures, and then trade in reaction to the mismatched numbers.
Even once you’re familiar with the behavioral biases that stand between you and clear-heading thinking, you’ll probably still be routinely tempted to react to the fear, greed, doubt, recklessness and similar hot emotions they generate. This is one reason an objective advisor can be such a critical ally, helping you move past your reactionary thinking into more deliberate decision-making for your long-term goals.
If you could use some help managing the behavioral biases that are likely lurking in your blind spot, give us a call. In combating that which you cannot see, two views are better than one.
The Top 5 Takeaways from Odds On
Dear friends,
It’s been 18 months since the release of Odds On, and every day since then I’ve been amazed and humbled by the response the book has generated. I could tell you some incredible stories about how Odds On is changing people’s lives by opening up the world of evidence-based investing. But the one thing that seems to resonate most with readers is how engaging and accessible the book is—how we’ve managed to humanize a topic that might otherwise seem technical and boring.
That was my goal from the start, but even after publishing the book I’ve wanted to make the lessons of Odds On even more accessible. To that end, I’ve highlighted the most important messages I hoped readers would discover in the book. Whether you’ve read it already and need a quick refresher or haven’t yet picked up a copy and are wondering what it’s all about, here are the key takeaways.
Takeaway #1. The traditional financial services industry (embodied by the giant Wall Street firms) is not about service. Wall Street is a sales machine, focused primarily on making money for itself by pushing actively-managed financial products with high fees that don’t necessarily serve the client’s best interests—or help them achieve their long-term goals.
Takeaway #2. Fortunately, there is a better way to invest. You can adopt an investment philosophy that’s based on logic, data and evidence to put the odds of success on your side. Thanks to smart academic researchers, we now understand where value comes from in the global financial markets (and where it doesn’t), and can put those findings to work in portfolios that offer exposure to the real drivers of long-term performance. In other words, investors can rely on science, not sales pitches and guesswork.
Even more heartening: Our philosophy is rapidly gaining ground against the old, sales-driven model. Just study the money moving each year into passively managed mutual funds and ETFs, as well as the flight from big brokerage houses to independent advisory firms, where true fiduciaries work in the best interest of their clients.
Takeaway #3. While the science is clear, our emotions are complicated. Human nature abhors change, and there is a lot of inertia behind investing behavior—whether we think we have to invest the way our parents and grandparents did or are still hanging on to old notions that “expert” stock pickers have the secret to long-term success. Some people can’t resist the idea that if they just read more articles about the best stocks or mutual funds or spend more time managing their investments, they’ll somehow beat the market.
But at some point you have to understand that evolving to evidence-based investing is not giving up control over your future—you’re actually taking control by accepting the science and embracing the course it lays out for us.
Takeaway #4. Even with academic evidence on your side, the world is unpredictable. Investment returns will fluctuate over time—sometimes painfully (remember 2008?). But you get rewarded precisely for taking those risks. The key to long-term success is not just embracing an evidence-based investment strategy, but staying disciplined and sticking with your plan in the face of short-term uncertainty. If you can’t do it on your own, you can work with someone who helps you stay disciplined. Remember, we’re playing the long game, and investors who are disciplined in the face of short-term chaos are the ones who are most likely to achieve their long-term goals.
Takeaway #5. Evidence-based investing improves your chances of better investment returns, but the greatest return of all is the freedom you gain. Reducing the time you spend obsessing over your investments or worrying about what’s going to happen to the markets tomorrow means you have more time to focus on what really matters to you—all those important things you’re saving and investing for in the first place. It’s liberating.
I hope these highlights have helped you understand a little more about why I wrote the book and what I believe everyone can gain when they embrace a rational, understandable investment approach. And if you or anyone else you know wants a copy of Odds On, just reach out to us by clicking below and we’ll send you one (hardback, kindle or audio). We want to change as many lives as we can, and Odds On has made that journey simpler and faster.
Thanks for taking the long view,
Matt
*All 2017 proceeds from sales of Odds On go to charity.
