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!

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.

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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.”

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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)

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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.

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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.

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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)

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

 

All of us at Hill Investment Group are still buzzing about the Houston Astros’ incredible World Series victory on November 1. This is the first World Series title for the franchise since it was founded in 1962, and we know how much this championship means for a city still recovering from the devastation of Hurricane Harvey.

We’re also thrilled for Astros General Manager Jeff Luhnow, who is also a good friend and was one of the first people to read and endorse my book, Odds On. When Jeff took over in 2011, the Astros were the worst team in baseball. Now, they’re World Champions, and they got there by taking down the three richest, most formidable teams: The Boston Red Sox, the New York Yankees and the Los Angeles Dodgers.

Any way you look at it, this was a monumental achievement. And even without these personal connections I’d still be thrilled by Houston’s victory, because of the way they did it: They adopted a rational, evidence-based strategy, and then had the patience and discipline to let it pay off.

The first thing Jeff and the Astros did to become winners was to take the long view: They didn’t have the budget to rebuild the team overnight with expensive players—and they probably wouldn’t have done that if they could because it wasn’t a sustainable approach. Instead, they decided to develop talent from the ground up, using advanced statistics to draft the best young players and to find veterans whose unique skill sets would diversify and strengthen the roster. Then they waited… losing a lot of games while slowly transforming themselves into a competitive team. Even as some fans grumbled about the losing, the team stuck with the plan and continued to make adjustments as needed, until their commitment was rewarded with the ultimate payoff.

This story should sound familiar to Hill Investment Group clients, because it’s a good analogy for what we’re doing in the investment world. Like the Astros, we’re taking on big, deep-pocketed competition. We’re also using a rational, data-driven approach that seeks to truly understand the factors that drive success. And once we’ve used those insights to develop a plan, we’re committed to see it through—trusting our process even in the face of temporary difficulties. Because as the Astros have proven, achieving the ultimate long-term goal sometimes requires short-term sacrifices.

So once again, Hill Investment Group offers our congratulations to Jeff Luhnow, the Houston Astros, and all of their fans. Nothing makes me happier than seeing people make brave choices, and then have the discipline to stand by those choices until they’re rewarded with greatness.

Take the long view,

Matt