Speaker 1: To day to strength to day. If you could change
Speaker 1: only one thing that would help your investing, what would
Speaker 1: it be? The answer? Your own behavior. We humans are
Speaker 1: a mess of biases and poor decision making. We only
Speaker 1: read or watch things we agree with. We forget our
Speaker 1: worst trades, and we allow our emotions to get the
Speaker 1: best of us. We are filled with unjustified overconfidence in
Speaker 1: our own abilities. As it turns out, when it comes
Speaker 1: to investing, we are our own worst enemies. I'm Barry
Speaker 1: Riddelts and on today's edition of At the Money, we're
Speaker 1: going to discuss how to best manage our own behavior
Speaker 1: for the health of our portfolios. To help us unpack
Speaker 1: all of this and what it means for your portfolio,
Speaker 1: let's bring in doctor William Bernstein. He is both a
Speaker 1: neurologist and a professional investor. He is the author of
Speaker 1: numerous books on investing, perhaps most famously The Four Pillars
Speaker 1: of Investing Lessons for Building a Winning Portfolio. So Bill,
Speaker 1: let's start with a simple observation from your research. When
Speaker 1: it comes to making risk allocation decisions in capital markets,
Speaker 1: we just ain't built for it.
Speaker 2: Explain well, Barry, our late places scene ancestors evolved in
Speaker 2: an environment with a risk horizon that was measured in seconds,
Speaker 2: sometimes fractions of a second, whereas in the modern era
Speaker 2: our financial risk arise and extends a half a century
Speaker 2: or so. So, in short, we are living in this
Speaker 2: space age with stone Age brains.
Speaker 1: So let's delve into those stone Age brains and how
Speaker 1: its evolutionary development leads us Australia in modern capital markets.
Speaker 1: What is it that our wetwear does to us?
Speaker 2: Well? My favorite analogy is what I call the skunk analogy,
Speaker 2: which is over the past ten or twenty million years,
Speaker 2: skunks of all a very effective strategy for dealing with
Speaker 2: large predators, which was to turn one hundred and eighty degrees,
Speaker 2: lift their tails, and spray. And that's very effective until
Speaker 2: they find themselves in a semi of environment where the
Speaker 2: biggest threat to their existence is a two ton hunk
Speaker 2: of steel moving at sixty miles an hour. That is
Speaker 2: exactly the wrong strategy. It's the same way with investing.
Speaker 2: When we mess up and we want to distance ourselves
Speaker 2: from our mistakes, we panic and we sell, which most
Speaker 2: of the time is the wrong response.
Speaker 1: I love this quote of yours to the extent you
Speaker 1: succeed in finance, you succeed by suppressing the limbic system,
Speaker 1: the very fast moving emotional system. If you cannot suppress that,
Speaker 1: you're going to die poor. Explain that to us.
Speaker 2: Well, our system one, that is our crew be speaking.
Speaker 2: Our repilian brain is where our fear and our greed live.
Speaker 2: So to give you a simple example, we evolve to
Speaker 2: think well of ourselves and to feel shame and discussed
Speaker 2: when we fail, which is a very effective evolutionary strategy
Speaker 2: in the late place to seem environment. And unfortunately, when
Speaker 2: we make a mistake in investing, we buy a sinco asset,
Speaker 2: we try to distance ourselves from it by selling in
Speaker 2: a panic. Now, the level of individual security is that
Speaker 2: may or may not be an effective response, but at
Speaker 2: the asset class level, it's generally best when you buy
Speaker 2: a bad acid class to either hold firm or to
Speaker 2: buy more.
Speaker 1: So let's get into some more details about that you observe.
Speaker 1: The single most important determinant of one's long term success
Speaker 1: is one's behavior during the worst two percent of markets.
Speaker 1: Why is that, Well.
Speaker 2: You can think of investing metaphorically as a highway on
Speaker 2: which you drive your assets from your present self to
Speaker 2: your future self, and most of the time the driving
Speaker 2: is pretty smooth, the road is pretty good. But occasionally
Speaker 2: they'll suddenly run into a massive pothole or a blind
Speaker 2: curve on a dangerous mountain pass with no guardrail, and
Speaker 2: that's the worst two percent of the time. So in general,
Speaker 2: the slower you drive, that is, the more conservative your portfolio,
Speaker 2: the more likely you are to convey those assets from
Speaker 2: your present self to your future self, that is, to
Speaker 2: complete the journey. And the message there is to invest
Speaker 2: more conservatively than you think you should, because two percent
Speaker 2: of the time it'll prevent you from bailing from the
Speaker 2: very effective long term strategy.
Speaker 1: So let's talk a little more about that two percent.
Speaker 1: I imagine the worst times for investor behavior is either at
Speaker 1: the very top of a bubble where people have a
Speaker 1: tendency to have pharmo and pile in, or at the
Speaker 1: very bottom of a market correction or crash, where people
Speaker 1: panic and capitulate and just dump everything of the lows.
Speaker 1: What's your experience been.
Speaker 2: My experience is the bottoms. That's more important. When I
Speaker 2: talk about the worst two percent of the time, I'm
Speaker 2: talking about you know, two thousand and eight, two thousand
Speaker 2: and nine. I'm talking about nineteen seventy three, nineteen seventy four,
Speaker 2: or nineteen thirty one nineteen thirty two, if you're familiar
Speaker 2: with that history. Compounding is magic, but you have to
Speaker 2: observe Charlie Munger's prime directive of compounding, which is to
Speaker 2: never interrupt it. So that's what you're trying to prevent.
Speaker 2: You're trying to prevent yourself from interrupting the magic of compounding.
Speaker 2: And you do that by paying attention to the worse
Speaker 2: two percent of the time and to design your portfolio
Speaker 2: with that worse two percent of the time in mind.
Speaker 1: Very interesting. So let's talk about one of the other
Speaker 1: issues that overconfidence seems to lead to, and that's glamor stocks.
Speaker 1: People seem to be seduced by these. It used to
Speaker 1: be Amazon, then it was Apple, then Tesla, today it's Nvidia.
Speaker 1: Why are we so taken by these household names that
Speaker 1: have had tremendous run ups in the market.
Speaker 2: Well, the economic historian Charlie Kindelberger said it best about
Speaker 2: a half century ago, which is, there's nothing so disturbing
Speaker 2: to one's well being in judgment as to see a
Speaker 2: friend get rich. And that's the problem with glamor stocks.
Speaker 2: Put another way, the history of stocks, the stocks of
Speaker 2: companies with revolutionary technologies that sell it stratospheric multiples. It's
Speaker 2: not unhappy history. Generally you wind up not doing terribly
Speaker 2: well when you do that.
Speaker 1: Another quote of yours that I love, the advent of
Speaker 1: free trading is like giving chainsaws to toddlers.
Speaker 2: Explain well, in the first place, commission free trading can
Speaker 2: be an advantage, just like a chainsaw can be a
Speaker 2: marvelous tool if you use it properly. So how do
Speaker 2: you use the chainsaw of free trading and low expenses
Speaker 2: effectively and safely? Well you do it by buying and
Speaker 2: holding low cost EPs an index funds. How do you
Speaker 2: use free trading improperly like a toddler with a chainsaw, Well,
Speaker 2: you trade stocks and even worse options all day long.
Speaker 2: If you're trading options all day long on a free platform,
Speaker 2: your wealth is going to melt like Iceland a hot pavement.
Speaker 1: So let's talk a little bit about that over confidence.
Speaker 1: Do most of us really believe we're smarter than the market.
Speaker 1: Do we really think we're stock picking or market timing geniuses?
Speaker 2: Yeah, we sure as heck do that whenever you trade
Speaker 2: a stock, you're saying you're smarter than the person on
Speaker 2: the other side of the trade, which is generally not true.
Speaker 2: And when you think that you can time the market,
Speaker 2: you're saying that you're smarter than the collected wisdom of
Speaker 2: the market, which is not true. You know more than
Speaker 2: ninety percent of the time. And if that's not over confidence,
Speaker 2: I don't know what is. But there's an overconfidence that's
Speaker 2: even worse than the overconfidence of stock picking and market timing,
Speaker 2: and that's over confidence about your risk tolerance. At the
Speaker 2: top of the market, everyone's a long term investor, and
Speaker 2: they don't take to heart my favorite quote from Fred
Speaker 2: Schweed's marvelous book, Where the Customer's Yachts, which is that
Speaker 2: there are certain things that cannot be adequately explained to
Speaker 2: a virgin, either by words or pictures, Nor can any
Speaker 2: description I might offer here even approximately what it feels
Speaker 2: like to lose a real chunk of money that you
Speaker 2: use to own. And that's what you run into when
Speaker 2: you're overconfident about your ability to tolerate risk.
Speaker 1: To say the very least. So there are a couple
Speaker 1: of other things in some of your books that really
Speaker 1: stood out when it came to human psychology, and one
Speaker 1: of the things that jumped out was, very often we
Speaker 1: rely on conventional wisdom. When the conventional wisdom is very
Speaker 1: often wrong. How does conventional wisdom lead us astray?
Speaker 2: Well, the conventional wisdom at a general sense is very
Speaker 2: often right. Conventional conventional market wisdom that you need to
Speaker 2: diversify to keep your expenses down, and there's a connection
Speaker 2: between risk and return. Those are all generally true. But
Speaker 2: where conventional wisdom falls down is when it comes to
Speaker 2: specific securities. And that's for one simple reason. The more
Speaker 2: favorably disposed the investing public is to a given stocklet say,
Speaker 2: the more its price has been driven up, and so
Speaker 2: the lower its future expected returns. Now, the converse is
Speaker 2: true of universally reviled assets. The time to own junk bonds,
Speaker 2: for example, is when the term becomes an epithet that's
Speaker 2: spat out of the speaker's mouth.
Speaker 1: One of my favorite Twitter accounts is called TikTok Investors,
Speaker 1: and this person pulls the most ridiculous investing strategies from
Speaker 1: TikTok and shares them. And the one I saw this
Speaker 1: morning was this woman who uses tarot cards to help
Speaker 1: her select option trades, and you could tell by her
Speaker 1: demeanor she really believes that this is useful and going
Speaker 1: to be a long term win.
Speaker 2: Yeah. One of my favorite quotes from Larry Thummers. It's
Speaker 2: a short and pithy one, which is there are idiots
Speaker 2: look around.
Speaker 1: So our final two questions, how can we overcome psychological
Speaker 1: biases to make better and more rational investment decisions?
Speaker 2: Well, first of all, you trade as little as possible,
Speaker 2: and secondly, you sort of psychologically internalize the Tobin separation theorem,
Speaker 2: which basically separates out acid classes by how much risk
Speaker 2: they have. And so in the Tobin separation theorem, there
Speaker 2: are only two acid classes. There's the risky one, which
Speaker 2: is stocks, which has high returns, and there's the safe one,
Speaker 2: which has low returns. And so the key thing is
Speaker 2: to cleanly separate those two things in your mind. And
Speaker 2: you do that by making sure that your riskless apps,
Speaker 2: riskless assets really are riskless. And you know, when the
Speaker 2: experiment hits, the ventilating the system, corporates and even municipal
Speaker 2: bonds are going to make you take a haircut on
Speaker 2: those holdings if you want to use them to buy
Speaker 2: cheap stocks or simply to pay for your groceries. Another
Speaker 2: way of saying that is there's a reason why Warren
Speaker 2: Buffett keeps twenty percent of Berkshire in t bills and
Speaker 2: cash equivalents.
Speaker 1: Sounds like you're describing the sixty forty portfolio.
Speaker 2: There's nothing wrong with the sixty forty portfolio. You know,
Speaker 2: once every couple of years you'll see a headline that
Speaker 2: the sixty forty portfolio is dead. And you know, I
Speaker 2: think that anybody who says that needs to wear a
Speaker 2: sandwich board that says I don't know what I'm talking about.
Speaker 1: Yeah, the last time that was said was right before
Speaker 1: a pretty substantial move down inequities, although to be fair,
Speaker 1: there was a modest move down in bonds as well.
Speaker 1: Our final question, how best should we manage our own
Speaker 1: investment behavior?
Speaker 2: Well, there's, as we alluded to earlier, there's system one,
Speaker 2: which is your you know, your emotional reptilian brain. And
Speaker 2: there's system two, which is your inner mister spock, your
Speaker 2: logical internal processes. And the trick is to train your
Speaker 2: system to your logical system, to listen to your system
Speaker 2: one and to learn when it's acting up. And I've
Speaker 2: I've found, for example, that the most profitable purchases I've
Speaker 2: made have been accomplished when I felt like I was
Speaker 2: about to thrill up.
Speaker 1: I know the feeling, so to wrap up. Overcoming our
Speaker 1: own psychology and making rational decisions is the key to
Speaker 1: long term success in the markets. Avoid trying to pick
Speaker 1: glamour stocks, avoid market timing, and most important of all,
Speaker 1: avoid giving in to your emotions when things get dangerous.
Speaker 1: Stay with your financial plan, invest for the long term,
Speaker 1: and you'll be fine. I'm Barry Redults and this is
Speaker 1: Bloomberg's At the Money