Latest / Masters in Business / At the Money: Behavior For Better Investing

Transcript

At the Money: Behavior For Better Investing · Masters in Business

• 0:00
  Speaker 1: To day to strength to day. If you could change
• 0:10
  Speaker 1: only one thing that would help your investing, what would
• 0:14
  Speaker 1: it be? The answer? Your own behavior. We humans are
• 0:19
  Speaker 1: a mess of biases and poor decision making. We only
• 0:23
  Speaker 1: read or watch things we agree with. We forget our
• 0:26
  Speaker 1: worst trades, and we allow our emotions to get the
• 0:30
  Speaker 1: best of us. We are filled with unjustified overconfidence in
• 0:34
  Speaker 1: our own abilities. As it turns out, when it comes
• 0:37
  Speaker 1: to investing, we are our own worst enemies. I'm Barry
• 0:42
  Speaker 1: Riddelts and on today's edition of At the Money, we're
• 0:45
  Speaker 1: going to discuss how to best manage our own behavior
• 0:49
  Speaker 1: for the health of our portfolios. To help us unpack
• 0:52
  Speaker 1: all of this and what it means for your portfolio,
• 0:55
  Speaker 1: let's bring in doctor William Bernstein. He is both a
• 0:59
  Speaker 1: neurologist and a professional investor. He is the author of
• 1:03
  Speaker 1: numerous books on investing, perhaps most famously The Four Pillars
• 1:08
  Speaker 1: of Investing Lessons for Building a Winning Portfolio. So Bill,
• 1:12
  Speaker 1: let's start with a simple observation from your research. When
• 1:16
  Speaker 1: it comes to making risk allocation decisions in capital markets,
• 1:22
  Speaker 1: we just ain't built for it.
• 1:23
  Speaker 2: Explain well, Barry, our late places scene ancestors evolved in
• 1:28
  Speaker 2: an environment with a risk horizon that was measured in seconds,
• 1:32
  Speaker 2: sometimes fractions of a second, whereas in the modern era
• 1:36
  Speaker 2: our financial risk arise and extends a half a century
• 1:39
  Speaker 2: or so. So, in short, we are living in this
• 1:42
  Speaker 2: space age with stone Age brains.
• 1:46
  Speaker 1: So let's delve into those stone Age brains and how
• 1:49
  Speaker 1: its evolutionary development leads us Australia in modern capital markets.
• 1:54
  Speaker 1: What is it that our wetwear does to us?
• 1:59
  Speaker 2: Well? My favorite analogy is what I call the skunk analogy,
• 2:04
  Speaker 2: which is over the past ten or twenty million years,
• 2:07
  Speaker 2: skunks of all a very effective strategy for dealing with
• 2:11
  Speaker 2: large predators, which was to turn one hundred and eighty degrees,
• 2:15
  Speaker 2: lift their tails, and spray. And that's very effective until
• 2:20
  Speaker 2: they find themselves in a semi of environment where the
• 2:23
  Speaker 2: biggest threat to their existence is a two ton hunk
• 2:26
  Speaker 2: of steel moving at sixty miles an hour. That is
• 2:29
  Speaker 2: exactly the wrong strategy. It's the same way with investing.
• 2:32
  Speaker 2: When we mess up and we want to distance ourselves
• 2:36
  Speaker 2: from our mistakes, we panic and we sell, which most
• 2:40
  Speaker 2: of the time is the wrong response.
• 2:43
  Speaker 1: I love this quote of yours to the extent you
• 2:46
  Speaker 1: succeed in finance, you succeed by suppressing the limbic system,
• 2:51
  Speaker 1: the very fast moving emotional system. If you cannot suppress that,
• 2:56
  Speaker 1: you're going to die poor. Explain that to us.
• 3:00
  Speaker 2: Well, our system one, that is our crew be speaking.
• 3:04
  Speaker 2: Our repilian brain is where our fear and our greed live.
• 3:08
  Speaker 2: So to give you a simple example, we evolve to
• 3:11
  Speaker 2: think well of ourselves and to feel shame and discussed
• 3:14
  Speaker 2: when we fail, which is a very effective evolutionary strategy
• 3:18
  Speaker 2: in the late place to seem environment. And unfortunately, when
• 3:22
  Speaker 2: we make a mistake in investing, we buy a sinco asset,
• 3:26
  Speaker 2: we try to distance ourselves from it by selling in
• 3:29
  Speaker 2: a panic. Now, the level of individual security is that
• 3:32
  Speaker 2: may or may not be an effective response, but at
• 3:35
  Speaker 2: the asset class level, it's generally best when you buy
• 3:39
  Speaker 2: a bad acid class to either hold firm or to
• 3:41
  Speaker 2: buy more.
• 3:44
  Speaker 1: So let's get into some more details about that you observe.
• 3:49
  Speaker 1: The single most important determinant of one's long term success
• 3:54
  Speaker 1: is one's behavior during the worst two percent of markets.
• 3:58
  Speaker 1: Why is that, Well.
• 4:01
  Speaker 2: You can think of investing metaphorically as a highway on
• 4:06
  Speaker 2: which you drive your assets from your present self to
• 4:10
  Speaker 2: your future self, and most of the time the driving
• 4:12
  Speaker 2: is pretty smooth, the road is pretty good. But occasionally
• 4:15
  Speaker 2: they'll suddenly run into a massive pothole or a blind
• 4:19
  Speaker 2: curve on a dangerous mountain pass with no guardrail, and
• 4:22
  Speaker 2: that's the worst two percent of the time. So in general,
• 4:26
  Speaker 2: the slower you drive, that is, the more conservative your portfolio,
• 4:30
  Speaker 2: the more likely you are to convey those assets from
• 4:33
  Speaker 2: your present self to your future self, that is, to
• 4:37
  Speaker 2: complete the journey. And the message there is to invest
• 4:40
  Speaker 2: more conservatively than you think you should, because two percent
• 4:43
  Speaker 2: of the time it'll prevent you from bailing from the
• 4:46
  Speaker 2: very effective long term strategy.
• 4:48
  Speaker 1: So let's talk a little more about that two percent.
• 4:51
  Speaker 1: I imagine the worst times for investor behavior is either at
• 4:57
  Speaker 1: the very top of a bubble where people have a
• 4:59
  Speaker 1: tendency to have pharmo and pile in, or at the
• 5:03
  Speaker 1: very bottom of a market correction or crash, where people
• 5:08
  Speaker 1: panic and capitulate and just dump everything of the lows.
• 5:12
  Speaker 1: What's your experience been.
• 5:15
  Speaker 2: My experience is the bottoms. That's more important. When I
• 5:18
  Speaker 2: talk about the worst two percent of the time, I'm
• 5:20
  Speaker 2: talking about you know, two thousand and eight, two thousand
• 5:23
  Speaker 2: and nine. I'm talking about nineteen seventy three, nineteen seventy four,
• 5:27
  Speaker 2: or nineteen thirty one nineteen thirty two, if you're familiar
• 5:31
  Speaker 2: with that history. Compounding is magic, but you have to
• 5:37
  Speaker 2: observe Charlie Munger's prime directive of compounding, which is to
• 5:42
  Speaker 2: never interrupt it. So that's what you're trying to prevent.
• 5:46
  Speaker 2: You're trying to prevent yourself from interrupting the magic of compounding.
• 5:51
  Speaker 2: And you do that by paying attention to the worse
• 5:54
  Speaker 2: two percent of the time and to design your portfolio
• 5:57
  Speaker 2: with that worse two percent of the time in mind.
• 6:01
  Speaker 1: Very interesting. So let's talk about one of the other
• 6:04
  Speaker 1: issues that overconfidence seems to lead to, and that's glamor stocks.
• 6:09
  Speaker 1: People seem to be seduced by these. It used to
• 6:12
  Speaker 1: be Amazon, then it was Apple, then Tesla, today it's Nvidia.
• 6:17
  Speaker 1: Why are we so taken by these household names that
• 6:21
  Speaker 1: have had tremendous run ups in the market.
• 6:25
  Speaker 2: Well, the economic historian Charlie Kindelberger said it best about
• 6:29
  Speaker 2: a half century ago, which is, there's nothing so disturbing
• 6:33
  Speaker 2: to one's well being in judgment as to see a
• 6:35
  Speaker 2: friend get rich. And that's the problem with glamor stocks.
• 6:39
  Speaker 2: Put another way, the history of stocks, the stocks of
• 6:43
  Speaker 2: companies with revolutionary technologies that sell it stratospheric multiples. It's
• 6:48
  Speaker 2: not unhappy history. Generally you wind up not doing terribly
• 6:53
  Speaker 2: well when you do that.
• 6:54
  Speaker 1: Another quote of yours that I love, the advent of
• 6:58
  Speaker 1: free trading is like giving chainsaws to toddlers.
• 7:02
  Speaker 2: Explain well, in the first place, commission free trading can
• 7:09
  Speaker 2: be an advantage, just like a chainsaw can be a
• 7:12
  Speaker 2: marvelous tool if you use it properly. So how do
• 7:14
  Speaker 2: you use the chainsaw of free trading and low expenses
• 7:18
  Speaker 2: effectively and safely? Well you do it by buying and
• 7:21
  Speaker 2: holding low cost EPs an index funds. How do you
• 7:27
  Speaker 2: use free trading improperly like a toddler with a chainsaw, Well,
• 7:31
  Speaker 2: you trade stocks and even worse options all day long.
• 7:34
  Speaker 2: If you're trading options all day long on a free platform,
• 7:38
  Speaker 2: your wealth is going to melt like Iceland a hot pavement.
• 7:42
  Speaker 1: So let's talk a little bit about that over confidence.
• 7:46
  Speaker 1: Do most of us really believe we're smarter than the market.
• 7:49
  Speaker 1: Do we really think we're stock picking or market timing geniuses?
• 7:55
  Speaker 2: Yeah, we sure as heck do that whenever you trade
• 7:58
  Speaker 2: a stock, you're saying you're smarter than the person on
• 8:01
  Speaker 2: the other side of the trade, which is generally not true.
• 8:05
  Speaker 2: And when you think that you can time the market,
• 8:07
  Speaker 2: you're saying that you're smarter than the collected wisdom of
• 8:09
  Speaker 2: the market, which is not true. You know more than
• 8:13
  Speaker 2: ninety percent of the time. And if that's not over confidence,
• 8:16
  Speaker 2: I don't know what is. But there's an overconfidence that's
• 8:20
  Speaker 2: even worse than the overconfidence of stock picking and market timing,
• 8:25
  Speaker 2: and that's over confidence about your risk tolerance. At the
• 8:30
  Speaker 2: top of the market, everyone's a long term investor, and
• 8:34
  Speaker 2: they don't take to heart my favorite quote from Fred
• 8:37
  Speaker 2: Schweed's marvelous book, Where the Customer's Yachts, which is that
• 8:41
  Speaker 2: there are certain things that cannot be adequately explained to
• 8:44
  Speaker 2: a virgin, either by words or pictures, Nor can any
• 8:47
  Speaker 2: description I might offer here even approximately what it feels
• 8:51
  Speaker 2: like to lose a real chunk of money that you
• 8:53
  Speaker 2: use to own. And that's what you run into when
• 8:57
  Speaker 2: you're overconfident about your ability to tolerate risk.
• 9:00
  Speaker 1: To say the very least. So there are a couple
• 9:02
  Speaker 1: of other things in some of your books that really
• 9:06
  Speaker 1: stood out when it came to human psychology, and one
• 9:10
  Speaker 1: of the things that jumped out was, very often we
• 9:14
  Speaker 1: rely on conventional wisdom. When the conventional wisdom is very
• 9:18
  Speaker 1: often wrong. How does conventional wisdom lead us astray?
• 9:23
  Speaker 2: Well, the conventional wisdom at a general sense is very
• 9:25
  Speaker 2: often right. Conventional conventional market wisdom that you need to
• 9:29
  Speaker 2: diversify to keep your expenses down, and there's a connection
• 9:32
  Speaker 2: between risk and return. Those are all generally true. But
• 9:36
  Speaker 2: where conventional wisdom falls down is when it comes to
• 9:38
  Speaker 2: specific securities. And that's for one simple reason. The more
• 9:43
  Speaker 2: favorably disposed the investing public is to a given stocklet say,
• 9:48
  Speaker 2: the more its price has been driven up, and so
• 9:50
  Speaker 2: the lower its future expected returns. Now, the converse is
• 9:54
  Speaker 2: true of universally reviled assets. The time to own junk bonds,
• 9:59
  Speaker 2: for example, is when the term becomes an epithet that's
• 10:02
  Speaker 2: spat out of the speaker's mouth.
• 10:04
  Speaker 1: One of my favorite Twitter accounts is called TikTok Investors,
• 10:08
  Speaker 1: and this person pulls the most ridiculous investing strategies from
• 10:13
  Speaker 1: TikTok and shares them. And the one I saw this
• 10:17
  Speaker 1: morning was this woman who uses tarot cards to help
• 10:22
  Speaker 1: her select option trades, and you could tell by her
• 10:28
  Speaker 1: demeanor she really believes that this is useful and going
• 10:32
  Speaker 1: to be a long term win.
• 10:34
  Speaker 2: Yeah. One of my favorite quotes from Larry Thummers. It's
• 10:37
  Speaker 2: a short and pithy one, which is there are idiots
• 10:40
  Speaker 2: look around.
• 10:42
  Speaker 1: So our final two questions, how can we overcome psychological
• 10:47
  Speaker 1: biases to make better and more rational investment decisions?
• 10:53
  Speaker 2: Well, first of all, you trade as little as possible,
• 10:57
  Speaker 2: and secondly, you sort of psychologically internalize the Tobin separation theorem,
• 11:02
  Speaker 2: which basically separates out acid classes by how much risk
• 11:07
  Speaker 2: they have. And so in the Tobin separation theorem, there
• 11:11
  Speaker 2: are only two acid classes. There's the risky one, which
• 11:14
  Speaker 2: is stocks, which has high returns, and there's the safe one,
• 11:16
  Speaker 2: which has low returns. And so the key thing is
• 11:19
  Speaker 2: to cleanly separate those two things in your mind. And
• 11:24
  Speaker 2: you do that by making sure that your riskless apps,
• 11:28
  Speaker 2: riskless assets really are riskless. And you know, when the
• 11:33
  Speaker 2: experiment hits, the ventilating the system, corporates and even municipal
• 11:38
  Speaker 2: bonds are going to make you take a haircut on
• 11:42
  Speaker 2: those holdings if you want to use them to buy
• 11:45
  Speaker 2: cheap stocks or simply to pay for your groceries. Another
• 11:49
  Speaker 2: way of saying that is there's a reason why Warren
• 11:51
  Speaker 2: Buffett keeps twenty percent of Berkshire in t bills and
• 11:54
  Speaker 2: cash equivalents.
• 11:55
  Speaker 1: Sounds like you're describing the sixty forty portfolio.
• 12:00
  Speaker 2: There's nothing wrong with the sixty forty portfolio. You know,
• 12:03
  Speaker 2: once every couple of years you'll see a headline that
• 12:05
  Speaker 2: the sixty forty portfolio is dead. And you know, I
• 12:10
  Speaker 2: think that anybody who says that needs to wear a
• 12:13
  Speaker 2: sandwich board that says I don't know what I'm talking about.
• 12:15
  Speaker 1: Yeah, the last time that was said was right before
• 12:20
  Speaker 1: a pretty substantial move down inequities, although to be fair,
• 12:23
  Speaker 1: there was a modest move down in bonds as well.
• 12:26
  Speaker 1: Our final question, how best should we manage our own
• 12:31
  Speaker 1: investment behavior?
• 12:34
  Speaker 2: Well, there's, as we alluded to earlier, there's system one,
• 12:37
  Speaker 2: which is your you know, your emotional reptilian brain. And
• 12:41
  Speaker 2: there's system two, which is your inner mister spock, your
• 12:46
  Speaker 2: logical internal processes. And the trick is to train your
• 12:51
  Speaker 2: system to your logical system, to listen to your system
• 12:54
  Speaker 2: one and to learn when it's acting up. And I've
• 12:58
  Speaker 2: I've found, for example, that the most profitable purchases I've
• 13:01
  Speaker 2: made have been accomplished when I felt like I was
• 13:04
  Speaker 2: about to thrill up.
• 13:06
  Speaker 1: I know the feeling, so to wrap up. Overcoming our
• 13:10
  Speaker 1: own psychology and making rational decisions is the key to
• 13:15
  Speaker 1: long term success in the markets. Avoid trying to pick
• 13:19
  Speaker 1: glamour stocks, avoid market timing, and most important of all,
• 13:24
  Speaker 1: avoid giving in to your emotions when things get dangerous.
• 13:29
  Speaker 1: Stay with your financial plan, invest for the long term,
• 13:32
  Speaker 1: and you'll be fine. I'm Barry Redults and this is
• 13:35
  Speaker 1: Bloomberg's At the Money