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Investment Commentary, Education, & Insight.
Saturday, September 24, 2011
Get Wiser: Gold, Tulips, Guns & Salt
Friday, September 9, 2011
Get Wiser: Retirement Date Funds and Chocolate
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Tuesday, September 6, 2011
Yeah, But. . .
Yeah, But. . .
We’ve all been in arguments when our counterpart is incapable of seeing our side, let alone agreeing with it. There is an important psychological lesson from this.
Humans prefer to see things as black and white— limiting possible realities to two opposing conclusions. This simplifies everything to a basic moral imperative: right vs. wrong. As in: I am right, you are wrong.
We are well advised to keep in mind when we believe the answer is either A or B - the rest of the alphabet is still on the table. And chances are the truest answer is another letter.
That things may not be cut and dry opens the possibility we may be wrong and is often refuted by both sides. This imperative is so strong our mind highlights any evidence that supports our conclusion on any given matter…after our decision has been made.
This polarizing process is called tactical justification. When making a decision we go with what our gut (emotional reaction) feels is right in the moment. This usually takes less than 40 seconds. Then our brain (logic) illuminates proof supporting our gut reaction. This can last a lifetime.
In investing, psychologists point to the primary behaviors at play: “Recency” and “Loss Aversion”. Recency is the tendency to weigh recent events with greater meaning than earlier events. This hurts investors by instilling the feeling that this time it is different, so they need to do something different.
Loss Aversion explains emotional reactions to losses. According to Behavioral Finance Psychologists Daniel Kahneman and Amos Tversky, reactions to loss are twice as powerful as those to gains. Therefore, in tumultuous markets we are more inclined to change plans than in good markets.
Pick any 40 year period and I will show that war, catastrophes, energy crises, financial debacles, recessions, bubbles, political upheaval, debt, trade deficits, global unrest, etc., have happened before. Yet the general feeling was this was new, we were in uncharted waters.
So it’s not what is happening now is not different. It’s that the people experiencing it are. It seems new because, to us, it is. A professor of English once told me: “Reading about something is one thing, living it is quite another.”
When living it, feelings strengthen into what I call the “Yeah, but” phenomena. This occurs in debates over any topic between polite, open-minded adversaries. It goes something like this:
One side makes a point justifying his/her conclusion and the other responds, ‘I agree on that point but,’ or ‘I understand how that could be interpreted that way but…’
As in, “Yeah, but…I’m still right and you’re still wrong.”
In investing, two options in the market are argued: Buy or Sell. Hundreds of studies show that choosing one over the other is detrimental in a portfolio. It’s called market timing. That’s why we systematically do both at the same time. It’s called rebalancing. Just as “the truth often lies in between,” selling of a portion of winners to buy underperformers has always proven the most successful strategy, including during recent events.
Even after strong positive returns over the last year, I’m hearing this from some investors:
“I want to go to cash and wait for the next recession, then I’ll get back in,” and “I need to perform immediate buys and sells as any investor requires during such times.” I listen to reasoning focused on current events— and remember such requests don’t happen when the market is going up. Perhaps Dan and Amos are on to something.
So how do we protect ourselves against psychological inclinations of which we’re unaware, given justification abounds that they are rationale and logical?
First, whenever we are inclined to change something we have a problem. We don’t change banks, CPAs, jobs, or portfolios unless we feel a better opportunity lies elsewhere. But firing your CPA because he’s a jerk is different than altering your portfolio because the market is jerking. There are tons of banks and CPAs, but there is only one market, and eventually she has always come around…every time.
Second, if you are considering portfolio changes, contact us. We want to know what you are thinking and feeling and a conversation can’t hurt.
In closing, Warren Buffett’s 2004 Berkshire Hathaway Annual Shareholder letter offers relevant advice in times like these (paraphrased):
Business has delivered terrific results the last 35 years. Therefore it should have been easy for investors to earn juicy returns: All they had to do was piggyback in a diversified, low-expense way. A rebalanced indexed portfolio never touched would have done the job. Instead many investors have met with disaster.
There are three reasons for this. High costs incurred by excessive trading and portfolio fees; portfolio changes based on tips and fads; and a start-and-stop approach marked by untimely entries and exits. Investors should remember that expenses, excitement and fear are their enemies.
I welcome questions and comments.
Warmly,
Marc Becker
If you would like to read more about behavioral finance click here.
We’ve all been in arguments when our counterpart is incapable of seeing our side, let alone agreeing with it. There is an important psychological lesson from this.
Humans prefer to see things as black and white— limiting possible realities to two opposing conclusions. This simplifies everything to a basic moral imperative: right vs. wrong. As in: I am right, you are wrong.
We are well advised to keep in mind when we believe the answer is either A or B - the rest of the alphabet is still on the table. And chances are the truest answer is another letter.
That things may not be cut and dry opens the possibility we may be wrong and is often refuted by both sides. This imperative is so strong our mind highlights any evidence that supports our conclusion on any given matter…after our decision has been made.
This polarizing process is called tactical justification. When making a decision we go with what our gut (emotional reaction) feels is right in the moment. This usually takes less than 40 seconds. Then our brain (logic) illuminates proof supporting our gut reaction. This can last a lifetime.
In investing, psychologists point to the primary behaviors at play: “Recency” and “Loss Aversion”. Recency is the tendency to weigh recent events with greater meaning than earlier events. This hurts investors by instilling the feeling that this time it is different, so they need to do something different.
Loss Aversion explains emotional reactions to losses. According to Behavioral Finance Psychologists Daniel Kahneman and Amos Tversky, reactions to loss are twice as powerful as those to gains. Therefore, in tumultuous markets we are more inclined to change plans than in good markets.
Pick any 40 year period and I will show that war, catastrophes, energy crises, financial debacles, recessions, bubbles, political upheaval, debt, trade deficits, global unrest, etc., have happened before. Yet the general feeling was this was new, we were in uncharted waters.
So it’s not what is happening now is not different. It’s that the people experiencing it are. It seems new because, to us, it is. A professor of English once told me: “Reading about something is one thing, living it is quite another.”
When living it, feelings strengthen into what I call the “Yeah, but” phenomena. This occurs in debates over any topic between polite, open-minded adversaries. It goes something like this:
One side makes a point justifying his/her conclusion and the other responds, ‘I agree on that point but,’ or ‘I understand how that could be interpreted that way but…’
As in, “Yeah, but…I’m still right and you’re still wrong.”
In investing, two options in the market are argued: Buy or Sell. Hundreds of studies show that choosing one over the other is detrimental in a portfolio. It’s called market timing. That’s why we systematically do both at the same time. It’s called rebalancing. Just as “the truth often lies in between,” selling of a portion of winners to buy underperformers has always proven the most successful strategy, including during recent events.
Even after strong positive returns over the last year, I’m hearing this from some investors:
“I want to go to cash and wait for the next recession, then I’ll get back in,” and “I need to perform immediate buys and sells as any investor requires during such times.” I listen to reasoning focused on current events— and remember such requests don’t happen when the market is going up. Perhaps Dan and Amos are on to something.
So how do we protect ourselves against psychological inclinations of which we’re unaware, given justification abounds that they are rationale and logical?
First, whenever we are inclined to change something we have a problem. We don’t change banks, CPAs, jobs, or portfolios unless we feel a better opportunity lies elsewhere. But firing your CPA because he’s a jerk is different than altering your portfolio because the market is jerking. There are tons of banks and CPAs, but there is only one market, and eventually she has always come around…every time.
Second, if you are considering portfolio changes, contact us. We want to know what you are thinking and feeling and a conversation can’t hurt.
In closing, Warren Buffett’s 2004 Berkshire Hathaway Annual Shareholder letter offers relevant advice in times like these (paraphrased):
Business has delivered terrific results the last 35 years. Therefore it should have been easy for investors to earn juicy returns: All they had to do was piggyback in a diversified, low-expense way. A rebalanced indexed portfolio never touched would have done the job. Instead many investors have met with disaster.
There are three reasons for this. High costs incurred by excessive trading and portfolio fees; portfolio changes based on tips and fads; and a start-and-stop approach marked by untimely entries and exits. Investors should remember that expenses, excitement and fear are their enemies.
I welcome questions and comments.
Warmly,
Marc Becker
If you would like to read more about behavioral finance click here.
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