Episode #41 - Boring
Why do we love excitement - even if it's bad for us
Intro:
Back in note #35 I introduced you folks to The Four Pillar’s of Investing and subsequently reviewed a few chapters before my self-imposed summer break. Now that I’m downloading your helpful comments around frequency/content/style (if you haven’t filled out the form, go for it here), I’m going to pull in something that never gets old for me and I’ll share it with you.
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Would you still go to the game?
Say you were planning to go with some friends to your college’s basketball game. To make this exciting, let’s assume your college has a great team, you like basketball, and there are a number of other magnets pulling you to the stadium. Then you look out your apartment, a 20 minute drive from the stadium, and see a blinding blizzard that would make the roads impossible to traverse. Would you go to the game?
In this same situation, Richard Thaler, at the time a young finance academic, and ultimately a big deal in what he called economics, and what others called behavioral finance, and his friends decided to abort their mission to go to the basketball game. However, his roommate commented, if they had already bought tickets, of course they’d go. First of all, would you?
Second of all, Thaler commented: “True — and interesting.” In the abstract world of econ. theory, a purchased ticket shouldn’t make a difference in this situation, but in the world of understanding human nature - it’s quite obvious that this is interesting.
Thaler made a career trying to understand the irrational decisions we make in daily life. He basically founded the whole discipline referenced above and went on to win a Nobel Prize in 2017.
If you’re into basketball and I haven’t lost you yet, Thaler’s the one who asked the brilliant question as to why when a team is down by two points (just one basket) in a game do they often attempt to tie the game when that is a 50/50 chance and THEN they would go into overtime with another 50/50 chance of winning, so a 25% chance of winning the game when they should really just go for three, which typically has a 33% success-rate and would give them a win.
The list of common misjudgments that humans make could take up a year’s worth of newsletters. Another classic that you might be familiar with is the statistic that 82% of young U.S. drivers considered themselves in the top 30% of their group in terms of safety. If you don’t have a math mind, that doesn’t show a lot of self-awareness.
Why do these behaviors matter?
No, I’ve not transformed this newsletter into a study of behavioral economics, and I’m not sure how often Thaler and his co-conspirators Daniel Kahneman and Amos Tversky will appear in these pages going forward, but I do think these tidbits tie nicely into understanding the beauty of boring in your financial portfolio.
An individual like me, and probably you, do not invest the time and resources that professional fund managers put in to picking their stocks. There are THOUSANDS of charts and spreadsheets that are being poured over constantly trying to find an edge or just a small advantage in the world of investing. Even when someone finds something to hang their hat on, they quickly get pulled down by other assets that they didn’t have the same success with which ends up ruining their “strong year” in a different category. To top it off, beating the market once is nice, but doing it consistently? That just doesn’t happen.
Bernstein quotes an ex-military pilot and financial advisor, Frank Armstrong, who shared that he knew people who “routinely faced death in the sky with equanimity but became physically ill when their portfolios declined 5%.” Short term losses scare us out of the market and then cause the casual investor to lose the gains that traditionally follow the losses. These are human tendencies, things that our brains can’t be rewired to avoid, but that is why boring is the antidote.
I’ve preached (though not made formal investing recommendations) about consistency and index funds and that’s because they protect you from being part of the military pilot class, who can handle falling out of a plane, but can’t watch their portfolio take a mild plunge.
Pattern recognition
One of the human “superpowers” is the ability to recognize patterns. These are skills that help us on a daily basis, Bernstein points out that the recognizable patterns exist in places like your sock drawer, but the markets have too many variables to create a coherent pattern. With an incoherent pattern, we’re bound to make significant judgement errors on our own.
On the flip-side, when we look to investment managers in the form of hedge-funds, you have high fees that come with the territory of being in an exclusive hedge-fund club. To overcome those high fees, the funds need to do SUPER WELL, so well that Bernstein proclaims “Lynch and Buffet in their heydays would have trouble overcoming.” Meaning the cost-structure is so high that the gains that seem “fantastic” get gobbled up by the funds themselves.
But wait, I want to have fun
In this note, I think more than any previous note, I’ve taken all the fun out of putting money in the market (see takeaway for more on that). I do think there is room to play with your money, but I think it needs to be done with the full understanding that you are doing just that: playing. And, the money you play with can’t be money you need to rely on for long-terms needs.
Takeaway:
Humans make poor assumptions all the time and we don’t think rationally when it comes to our understanding of the world around us - especially when it comes to markets. Markets must be seen as not something we are exceptional and BETTER at dealing with, rather it’s in the same category as that coach who for years was recommending “go for the tie” for the last second shot, to then lose in overtime.
Interact:
What is a real life case you’re thinking about that has some risk where you think you might be making the wrong choice?
I’ll give an example, I just got a jury duty summons that takes place over the Jewish holiday of Sukkot. I can call ahead and get an exemption because of my practice, right? On the flip side, I can wait until the day I need to call the office and not get invited to jury duty. Then I’d be off the hook for who knows how long, but I might get called in and have bigger fish to fry. I have no clue what the odds are here, but I’m curious if this is a Thaler-esque error I’m making. What do you think?
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Please remember, I’m not providing professional advice about personal finance. I’ve got a lot of friends who do that and you can totally hit me up for an intro if you’d like - I don’t get any commission - just the happiness that my readers are taking their financial health seriously.