Seven Ways to Fool Yourself

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The philosopher Ludwig Wittgenstein once said that nothing is as difficult for people as not deceiving themselves. But while most self-delusions are relatively costless, those relating to investment can come with a hefty price tag.

We delude ourselves for a number of reasons, but one of the principal causes is a need to protect our own egos. So we look for external evidence that supports the myths we hold about ourselves, and we dismiss those facts that are incompatible.

Psychologists call this “confirmation bias”—a tendency to select facts that suit our own internal beliefs. A related ingrained tendency, known as “hindsight bias,” involves seeing everything as obvious and predictable after the fact.

These biases, or ways of protecting our egos from reality, are evident among many investors every day and are often encouraged by the media.

Here are seven common manifestations of how investors fool themselves:

  1. “Everyone could see that market crash coming.” Have you noticed how people become experts after the fact? But if “everyone” could see a correction coming, why wasn’t “everyone” profiting from it? You don’t need forecasts.
  1. “I only invest in ‘blue-chip’ companies.” People often gravitate to the familiar and to shares they see as solid. But a company’s profile and whether or not it is a good investment are not necessarily correlated. Better to diversify.
  1. “I’m waiting for more certainty.” The emotions triggered by volatility are understandable, but acting on those emotions can be counterproductive. Uncertainty goes with investing. Historically, long-term discipline has been rewarded.
  1. “I know about this industry, so I’m going to buy the stock.” People often assume that success in investment requires a specialist’s knowledge of a sector. But that information is usually already in the price. Trust the market instead.
  1. “It was still a good call, but no one saw this coming.” Isn’t that the point? You can rationalize a stock-specific bet as much as you like, but events or external influences can conspire against you. Spread your risk instead.
  1. “I’m going to restrict my portfolio to the strongest economies.” If an economy performs strongly, that will no doubt be reflected in stock prices. What moves prices is news. And news relates to the unexpected. So work with the market.
  1. “OK, it was a bad idea, but I don’t want to sell at a loss.” We can put too much faith in individual stocks, and holding onto a losing bet can mean missing opportunities elsewhere. Portfolio structure affects performance.

This is by no means an exhaustive list. In fact, the capacity for human beings to delude themselves in the world of investment is never-ending.

But overcoming self-deception is not impossible. It just starts with recognizing that, as humans, we are not wired for disciplined investing. We will always find one way or another of rationalizing an emotional reaction to market events.

But that’s why even experienced investors engage advisors who know them, and who understand their circumstances, risk appetites, and long-term goals. The role of that advisor is to listen to and acknowledge our very human fears, while keeping us in the plans we committed to at our most lucid and logical.

We will always try to fool ourselves. But to quote a piece of folk wisdom, the essence of self-discipline is to do the important thing rather than the urgent thing.

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

 

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

Not Rocket Science

Rocket Scientist

When the media raises the subject of beating the market through astute stock picking, the name Warren Buffett is usually cited. But what does this legendary investor actually say about the smart way to invest?

Buffett is considered to have such a track record of picking stock winners and avoiding losers that his annual letter to shareholders in his Berkshire Hathaway conglomerate is treated as a major event by the financial media.1

What does he think about the Federal Reserve taper? What could be the implications for emerging markets of a Russian military advance into Ukraine? What does an economic slowdown in China mean for developed markets?

Buffett has a neat way of parrying these questions from journalists and analysts. Instead of offering instant opinions about the crisis of the day, he recounts in his most recent annual letter a folksy story about a farm he has owned for nearly 30 years.2

Has he laid awake at night worrying about fluctuations in the farm’s market price? No, says Buffett, he has focused on its long-term value. And he counsels investors to take the same sanguine, relaxed approach to liquid investments such as shares as they do to the value of their family home.

“Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations,” Buffett said. “For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.”

While many individuals seek to ape Buffett in analyzing individual companies in minute detail in the hope of finding a bargain, he advocates that the right approach for most people is to let the market do all the work and worrying for them.

“The goal of the non-professional should not be to pick winners,” Buffett wrote in his annual letter. “The ‘know-nothing’ investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.”

As to all the predictions out there about interest rates, emerging markets, or geopolitics, there will always be a range of opinions, he says. But we are under no obligation to listen to the media commentators, however distracting they may be.

“Owners of stocks . . . too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally,” Buffett says. “Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits—and, worse yet, important to consider acting upon their comments.”

The Buffett prescription isn’t rocket science, as one might expect from an unassuming, plainspoken octogenarian from Nebraska. He rightly points out that an advanced intellect and success in long-term investment don’t necessarily go together.

“You don’t need to be a rocket scientist,” he has said. “Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”3

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

1. “Buffet Warns of Liquidity Curse,” Bloomberg, Feb 25, 2014.

2. Berkshire Hathaway Inc. shareholder letter, 2013, www.berkshirehathaway.com/letters/2013ltr.pdf.

3. “The wit and wisdom of Warren Buffett,” Fortune, November 19, 2012, management.fortune.cnn.com/2012/11/19/warren-buffett-wit-wisdom/.

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.