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Speaker 1: To day to strength to day. If you could change

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Speaker 1: only one thing that would help your investing, what would

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Speaker 1: it be? The answer? Your own behavior. We humans are

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Speaker 1: a mess of biases and poor decision making. We only

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Speaker 1: read or watch things we agree with. We forget our

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Speaker 1: worst trades, and we allow our emotions to get the

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Speaker 1: best of us. We are filled with unjustified overconfidence in

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Speaker 1: our own abilities. As it turns out, when it comes

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Speaker 1: to investing, we are our own worst enemies. I'm Barry

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Speaker 1: Riddelts and on today's edition of At the Money, we're

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Speaker 1: going to discuss how to best manage our own behavior

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Speaker 1: for the health of our portfolios. To help us unpack

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Speaker 1: all of this and what it means for your portfolio,

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Speaker 1: let's bring in doctor William Bernstein. He is both a

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Speaker 1: neurologist and a professional investor. He is the author of

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Speaker 1: numerous books on investing, perhaps most famously The Four Pillars

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Speaker 1: of Investing Lessons for Building a Winning Portfolio. So Bill,

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Speaker 1: let's start with a simple observation from your research. When

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Speaker 1: it comes to making risk allocation decisions in capital markets,

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Speaker 1: we just ain't built for it.

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Speaker 2: Explain well, Barry, our late places scene ancestors evolved in

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Speaker 2: an environment with a risk horizon that was measured in seconds,

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Speaker 2: sometimes fractions of a second, whereas in the modern era

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Speaker 2: our financial risk arise and extends a half a century

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Speaker 2: or so. So, in short, we are living in this

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Speaker 2: space age with stone Age brains.

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Speaker 1: So let's delve into those stone Age brains and how

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Speaker 1: its evolutionary development leads us Australia in modern capital markets.

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Speaker 1: What is it that our wetwear does to us?

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Speaker 2: Well? My favorite analogy is what I call the skunk analogy,

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Speaker 2: which is over the past ten or twenty million years,

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Speaker 2: skunks of all a very effective strategy for dealing with

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Speaker 2: large predators, which was to turn one hundred and eighty degrees,

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Speaker 2: lift their tails, and spray. And that's very effective until

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Speaker 2: they find themselves in a semi of environment where the

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Speaker 2: biggest threat to their existence is a two ton hunk

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Speaker 2: of steel moving at sixty miles an hour. That is

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Speaker 2: exactly the wrong strategy. It's the same way with investing.

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Speaker 2: When we mess up and we want to distance ourselves

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Speaker 2: from our mistakes, we panic and we sell, which most

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Speaker 2: of the time is the wrong response.

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Speaker 1: I love this quote of yours to the extent you

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Speaker 1: succeed in finance, you succeed by suppressing the limbic system,

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Speaker 1: the very fast moving emotional system. If you cannot suppress that,

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Speaker 1: you're going to die poor. Explain that to us.

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Speaker 2: Well, our system one, that is our crew be speaking.

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Speaker 2: Our repilian brain is where our fear and our greed live.

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Speaker 2: So to give you a simple example, we evolve to

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Speaker 2: think well of ourselves and to feel shame and discussed

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Speaker 2: when we fail, which is a very effective evolutionary strategy

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Speaker 2: in the late place to seem environment. And unfortunately, when

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Speaker 2: we make a mistake in investing, we buy a sinco asset,

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Speaker 2: we try to distance ourselves from it by selling in

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Speaker 2: a panic. Now, the level of individual security is that

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Speaker 2: may or may not be an effective response, but at

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Speaker 2: the asset class level, it's generally best when you buy

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Speaker 2: a bad acid class to either hold firm or to

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Speaker 2: buy more.

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Speaker 1: So let's get into some more details about that you observe.

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Speaker 1: The single most important determinant of one's long term success

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Speaker 1: is one's behavior during the worst two percent of markets.

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Speaker 1: Why is that, Well.

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Speaker 2: You can think of investing metaphorically as a highway on

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Speaker 2: which you drive your assets from your present self to

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Speaker 2: your future self, and most of the time the driving

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Speaker 2: is pretty smooth, the road is pretty good. But occasionally

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Speaker 2: they'll suddenly run into a massive pothole or a blind

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Speaker 2: curve on a dangerous mountain pass with no guardrail, and

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Speaker 2: that's the worst two percent of the time. So in general,

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Speaker 2: the slower you drive, that is, the more conservative your portfolio,

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Speaker 2: the more likely you are to convey those assets from

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Speaker 2: your present self to your future self, that is, to

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Speaker 2: complete the journey. And the message there is to invest

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Speaker 2: more conservatively than you think you should, because two percent

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Speaker 2: of the time it'll prevent you from bailing from the

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Speaker 2: very effective long term strategy.

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Speaker 1: So let's talk a little more about that two percent.

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Speaker 1: I imagine the worst times for investor behavior is either at

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Speaker 1: the very top of a bubble where people have a

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Speaker 1: tendency to have pharmo and pile in, or at the

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Speaker 1: very bottom of a market correction or crash, where people

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Speaker 1: panic and capitulate and just dump everything of the lows.

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Speaker 1: What's your experience been.

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Speaker 2: My experience is the bottoms. That's more important. When I

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Speaker 2: talk about the worst two percent of the time, I'm

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Speaker 2: talking about you know, two thousand and eight, two thousand

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Speaker 2: and nine. I'm talking about nineteen seventy three, nineteen seventy four,

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Speaker 2: or nineteen thirty one nineteen thirty two, if you're familiar

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Speaker 2: with that history. Compounding is magic, but you have to

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Speaker 2: observe Charlie Munger's prime directive of compounding, which is to

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Speaker 2: never interrupt it. So that's what you're trying to prevent.

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Speaker 2: You're trying to prevent yourself from interrupting the magic of compounding.

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Speaker 2: And you do that by paying attention to the worse

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Speaker 2: two percent of the time and to design your portfolio

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Speaker 2: with that worse two percent of the time in mind.

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Speaker 1: Very interesting. So let's talk about one of the other

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Speaker 1: issues that overconfidence seems to lead to, and that's glamor stocks.

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Speaker 1: People seem to be seduced by these. It used to

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Speaker 1: be Amazon, then it was Apple, then Tesla, today it's Nvidia.

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Speaker 1: Why are we so taken by these household names that

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Speaker 1: have had tremendous run ups in the market.

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Speaker 2: Well, the economic historian Charlie Kindelberger said it best about

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Speaker 2: a half century ago, which is, there's nothing so disturbing

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Speaker 2: to one's well being in judgment as to see a

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Speaker 2: friend get rich. And that's the problem with glamor stocks.

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Speaker 2: Put another way, the history of stocks, the stocks of

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Speaker 2: companies with revolutionary technologies that sell it stratospheric multiples. It's

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Speaker 2: not unhappy history. Generally you wind up not doing terribly

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Speaker 2: well when you do that.

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Speaker 1: Another quote of yours that I love, the advent of

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Speaker 1: free trading is like giving chainsaws to toddlers.

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Speaker 2: Explain well, in the first place, commission free trading can

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Speaker 2: be an advantage, just like a chainsaw can be a

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Speaker 2: marvelous tool if you use it properly. So how do

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Speaker 2: you use the chainsaw of free trading and low expenses

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Speaker 2: effectively and safely? Well you do it by buying and

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Speaker 2: holding low cost EPs an index funds. How do you

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Speaker 2: use free trading improperly like a toddler with a chainsaw, Well,

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Speaker 2: you trade stocks and even worse options all day long.

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Speaker 2: If you're trading options all day long on a free platform,

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Speaker 2: your wealth is going to melt like Iceland a hot pavement.

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Speaker 1: So let's talk a little bit about that over confidence.

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Speaker 1: Do most of us really believe we're smarter than the market.

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Speaker 1: Do we really think we're stock picking or market timing geniuses?

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Speaker 2: Yeah, we sure as heck do that whenever you trade

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Speaker 2: a stock, you're saying you're smarter than the person on

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Speaker 2: the other side of the trade, which is generally not true.

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Speaker 2: And when you think that you can time the market,

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Speaker 2: you're saying that you're smarter than the collected wisdom of

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Speaker 2: the market, which is not true. You know more than

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Speaker 2: ninety percent of the time. And if that's not over confidence,

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Speaker 2: I don't know what is. But there's an overconfidence that's

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Speaker 2: even worse than the overconfidence of stock picking and market timing,

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Speaker 2: and that's over confidence about your risk tolerance. At the

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Speaker 2: top of the market, everyone's a long term investor, and

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Speaker 2: they don't take to heart my favorite quote from Fred

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Speaker 2: Schweed's marvelous book, Where the Customer's Yachts, which is that

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Speaker 2: there are certain things that cannot be adequately explained to

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Speaker 2: a virgin, either by words or pictures, Nor can any

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Speaker 2: description I might offer here even approximately what it feels

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Speaker 2: like to lose a real chunk of money that you

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Speaker 2: use to own. And that's what you run into when

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Speaker 2: you're overconfident about your ability to tolerate risk.

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Speaker 1: To say the very least. So there are a couple

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Speaker 1: of other things in some of your books that really

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Speaker 1: stood out when it came to human psychology, and one

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Speaker 1: of the things that jumped out was, very often we

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Speaker 1: rely on conventional wisdom. When the conventional wisdom is very

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Speaker 1: often wrong. How does conventional wisdom lead us astray?

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Speaker 2: Well, the conventional wisdom at a general sense is very

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Speaker 2: often right. Conventional conventional market wisdom that you need to

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Speaker 2: diversify to keep your expenses down, and there's a connection

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Speaker 2: between risk and return. Those are all generally true. But

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Speaker 2: where conventional wisdom falls down is when it comes to

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Speaker 2: specific securities. And that's for one simple reason. The more

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Speaker 2: favorably disposed the investing public is to a given stocklet say,

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Speaker 2: the more its price has been driven up, and so

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Speaker 2: the lower its future expected returns. Now, the converse is

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Speaker 2: true of universally reviled assets. The time to own junk bonds,

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Speaker 2: for example, is when the term becomes an epithet that's

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Speaker 2: spat out of the speaker's mouth.

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Speaker 1: One of my favorite Twitter accounts is called TikTok Investors,

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Speaker 1: and this person pulls the most ridiculous investing strategies from

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Speaker 1: TikTok and shares them. And the one I saw this

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Speaker 1: morning was this woman who uses tarot cards to help

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Speaker 1: her select option trades, and you could tell by her

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Speaker 1: demeanor she really believes that this is useful and going

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Speaker 1: to be a long term win.

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Speaker 2: Yeah. One of my favorite quotes from Larry Thummers. It's

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Speaker 2: a short and pithy one, which is there are idiots

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Speaker 2: look around.

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Speaker 1: So our final two questions, how can we overcome psychological

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Speaker 1: biases to make better and more rational investment decisions?

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Speaker 2: Well, first of all, you trade as little as possible,

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Speaker 2: and secondly, you sort of psychologically internalize the Tobin separation theorem,

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Speaker 2: which basically separates out acid classes by how much risk

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Speaker 2: they have. And so in the Tobin separation theorem, there

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Speaker 2: are only two acid classes. There's the risky one, which

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Speaker 2: is stocks, which has high returns, and there's the safe one,

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Speaker 2: which has low returns. And so the key thing is

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Speaker 2: to cleanly separate those two things in your mind. And

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Speaker 2: you do that by making sure that your riskless apps,

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Speaker 2: riskless assets really are riskless. And you know, when the

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Speaker 2: experiment hits, the ventilating the system, corporates and even municipal

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Speaker 2: bonds are going to make you take a haircut on

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Speaker 2: those holdings if you want to use them to buy

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Speaker 2: cheap stocks or simply to pay for your groceries. Another

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Speaker 2: way of saying that is there's a reason why Warren

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Speaker 2: Buffett keeps twenty percent of Berkshire in t bills and

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Speaker 2: cash equivalents.

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Speaker 1: Sounds like you're describing the sixty forty portfolio.

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Speaker 2: There's nothing wrong with the sixty forty portfolio. You know,

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Speaker 2: once every couple of years you'll see a headline that

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Speaker 2: the sixty forty portfolio is dead. And you know, I

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Speaker 2: think that anybody who says that needs to wear a

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Speaker 2: sandwich board that says I don't know what I'm talking about.

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Speaker 1: Yeah, the last time that was said was right before

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Speaker 1: a pretty substantial move down inequities, although to be fair,

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Speaker 1: there was a modest move down in bonds as well.

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Speaker 1: Our final question, how best should we manage our own

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Speaker 1: investment behavior?

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Speaker 2: Well, there's, as we alluded to earlier, there's system one,

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Speaker 2: which is your you know, your emotional reptilian brain. And

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Speaker 2: there's system two, which is your inner mister spock, your

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Speaker 2: logical internal processes. And the trick is to train your

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Speaker 2: system to your logical system, to listen to your system

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Speaker 2: one and to learn when it's acting up. And I've

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Speaker 2: I've found, for example, that the most profitable purchases I've

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Speaker 2: made have been accomplished when I felt like I was

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Speaker 2: about to thrill up.

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Speaker 1: I know the feeling, so to wrap up. Overcoming our

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Speaker 1: own psychology and making rational decisions is the key to

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Speaker 1: long term success in the markets. Avoid trying to pick

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Speaker 1: glamour stocks, avoid market timing, and most important of all,

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Speaker 1: avoid giving in to your emotions when things get dangerous.

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Speaker 1: Stay with your financial plan, invest for the long term,

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Speaker 1: and you'll be fine. I'm Barry Redults and this is

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Speaker 1: Bloomberg's At the Money