How your cognitive biases lead to terrible investing behaviors

You probably think investing is about markets and strategy, but Barry Rithotz argues that it’s actually about biology. 

Our brains evolved to spot danger, not to manage portfolios, and the instincts that once kept us alive now push us towards panic and greed. That same wiring that told our ancestors to run from predators now tells modern investors to sell at the bottom.

BARRY RITHOLTZ: I think a lot of people don’t realize that investing is a problem that’s been solved. We know what the average returns are for equity, for fixed income. We know what inflation looks like over the long haul. We know what the economy broadly does, what the range looks like. The variable, the wild card, that we haven’t yet solved for is our own behavior. There have been literally thousands of books telling people, “Here’s how to invest,” but you could do everything right for years and years and years and if you just make one or two mistakes, all of that hard work goes out the window. Instead of telling people what to do, let’s tell them what not to do. Let me walk you through the biggest traps that you should be aware of that are a danger to your financial wellbeing. I’m Barry Ritholtz and I’m chairman and chief investment officer of Ritholtz Wealth Management. My new book is “How Not to Invest: The Ideas, Numbers, and Behaviors that Destroy Wealth and How to Avoid Them.”

– [Narrator] Chapter 1: Why your brain makes you a bad investor.

– So our brain is this wonderfully evolved organ. It’s less than 5% of our body weight, it consumes 20% of our energy, and our big brains are what’s helped us essentially dominate the planet. We’re a social cooperative species. We’ve evolved and adapted in a very hostile world. And all of the instinctual lessons we’ve learned over the past 2 million years, all of the way we’re wired, are geared to keep us alive in those sort of dangerous circumstances. We’re highly attuned to existential threats. We’re primed towards action. We tend to notice really bad news, and we tend to ignore good news. Why? Because these are all successful survival strategies in the wild. The modern markets have existed for a century or two. There were no municipal bond markets 500 years ago. There were barely equity markets 400 years ago. And so to imagine that 2 million years of evolution somehow prepares you to make decisions. You know, most of human history, we live 20, 25, 30 years. The idea of having to save and invest for decades in the future, it’s just so out of our realm. When we look at how stocks compound, these are just far, far outside of our instinctual experience. We simply have a hard time imagining the way that math works because exponential math didn’t help keep you alive on the savanna. And so we’re in a situation where, the pharmaceutical companies call this off-label when they give you a drug for a reason that’s not it’s originally intended purpose, we use our brains off-label. Our brains help keep us alive in a hostile competitive environment. We’re using our brains today to pick stocks, to make asset allocations, to make long-term financial decisions. We simply were never built for this. And so it’s in our interest to be thoughtful, to understand why we make these errors and to try our best to avoid them if we wanna succeed in the financial markets. So it’s very useful for investors to develop a little bit of a spidey sense, a little bit of a self-awareness as to what’s motivating their behavior. So let’s talk about how our own cognitive errors and biases lead to bad decision making when it comes to investing. Let’s talk about your limbic system. I want to share a quote from a friend, Dr. William Bernstein is a neurologist and investor, and he said the secret to success in investing is managing your limbic system. That’s the part of the brain that’s responsible for your fight-or-flight response. “Learn to control your limbic system or else you will die poor.” That’s a pretty strong statement, but it comes from somebody who’s studied this over the past few decades. And our inability to manage our emotions, our sense of greed and panic often leads us to bad decisions. I love the metaphor of “Star Trek’s” Mr. Spock as a metaphor for the stock market, right? Mr. Spock is half Vulcan, half human, one half of his thought process is very logical, but he’s also influenced by his emotions, his mother’s side of the equation. And when we see the stock market, the Spock market, we see that very often it’s some rationality and logic fighting with emotions. Most of the time the market is fairly rational. It’s a future discounting mechanism. It takes stock prices and it says, “Here’s what our best estimates are of future revenue and profits. And that means prices should be somewhere along this line.” There are times when the human emotional half intervenes. We see it when markets go vertical, when things get crazy. Think about late 1999 and early 2000 when everybody said, “I have to own me some of these dot-coms,” and piled in. Sometimes it’s to the bottom. Think about March, 2009, when people were convinced stocks were going to zero. The credit markets are frozen, the government doesn’t know what it’s doing, stocks are going to zero. And the people who capitulated, the people who panic sold, they regretted it. When the S&P 500 hit 666 in early March of 2009, that was a reflection of the emotionality of all the people in the market just panicking and fleeing. Here we are 15 years later, almost 10x higher. Logic tells us that we need to be invested for the long term and also tells us that we have to control our emotions so we don’t panic chase stocks up in 2000 and then panic sell stocks at the lows in 2009. So humans evolved emotions as a way to help keep us alive, to keep us alive on the savanna. And so when you have this strong feeling, your natural tendency is to do something about it. If it’s fear, well you wanna make the pain go away. You wanna stop. What that manifests itself as during a market sell off is a little bit of panic and people sell because they’re afraid they’re gonna lose their money. The flip side of that is the greed button. We’re jealous, we’re envious. We wanna have not just money and wealth, but we want to think of ourselves as intelligent and successful. And the way we do that is by buying the stocks that are going up the most. And so when the market is rallying, there is a tendency to stampede into the best performers. You know, the old joke is, there’s nothing more frustrating than seeing the idiot down the block become rich when you are not. And so FOMO, the fear of missing out, is simply, “Why didn’t I buy Bitcoin at 50 cents? Why aren’t I in NVIDIA at $2? Why didn’t I buy gold at 500?” On and on it goes. The answer is there was no basis, no rational, reasonable basis for you to buy any of those things at those prices. Our emotions get in our way because they’re not part of our long-term plan. They’re part of our evolutionary wiring, our wetware. Look at what took place during the pandemic with GameStop and Hertz and all of these other companies that skyrocketed in value and then turned around and crashed. These aren’t investments, these are speculative bets. Hey, God bless anybody who bought GameStop, you know, at a buck and sold it, you know, 10 or 50 or a 100x higher. I’m thrilled for people who do that. The problem is most of us had no reason to think that was any sort of investment. It turned out to be a speculation. Some people made money, a lot of people lost money. But the bottom line is, that’s not investing, that’s speculation. I am all in favor of setting up a cowboy account if you like that sort of thing. Take 3, 4, 5% of your liquid net worth and put it into a trading account. Have at it. Buy all the Bitcoin and GameStop and stock options you want to trade with, but understand two things. If it works out, well, great. It probably wouldn’t have worked out if it was all of your assets. Imagine you have your your stock allocation and it’s up 2x, 3x, 4x. People start to panic and say, “Hey, I gotta protect these gains,” instead of investing for the long run. With 2, 3, 4%, you could let that run and it doesn’t really matter. It’s not gonna cause that sort of fear of losing all your money. On the other hand, if it crashes and burns, if it goes to zero, well thank goodness it was 3% and not your entire portfolio. The advantage of a personal account, a cowboy account, is it doesn’t matter how high it goes or how low it goes, if it scratches that itch from me, it forces my big dumb lizard brain to leave the rest of my money alone. Another bias you should be aware of is narrative fallacy. Look, humans are storytelling animals. We haven’t had a written language for most of our history. In fact, it’s only over the past few hundred years that most of us know how to read and write. And so telling compelling stories was a really important way to share information person to person, generation to generation. But the problem with that is compelling stories sometimes walk right past data warning against danger, warning against problems. We’ve seen all sorts of different things come out that attract our attention. Different trading apps, NFTs, SPACs, all these different investing products, these financial products, they have their moment in the sun, they catch our attention. Some people who are in there early do well. Everybody else who plows in late, they’re the suckers at the poker table, they’re left holding the bag. And so we’ve seen all sorts of companies with a great narrative tale around it fail to see the data supporting that narrative. The numbers matter just as much, if not more, than the narrative. There’s a tendency for us to look at something and say, “Hey, how hard can it be?” Not realizing that most complex endeavors involve practice and expertise and study to become even marginally good at it. In fact, there’s an entire field of study called the Dunning-Kruger effect that the ability to evaluate our own skillset, also known as metacognition, is in and of itself a discrete skill. And so very often people who lack a particular skill are unaware that they don’t have that skill. And you could see this in sports and we see it in investing. Newbies have a tendency to not only be overconfident, but also to have no set of awareness of how lacking they are in skills. And so this is why we should make fewer decisions and try and make less unforced errors. So let’s talk about confirmation bias. The world is not black and white. It’s full of nuance and shades of gray. No matter what position you’re taking about this stock or this sector or whatever it is you want to put your money into, it’s not that hard to find arguments either in favor of that investment or against that investment. Confirmation is a problem when we’re thinking about deploying capital into a specific asset and then go out seeking information that just supports our view. We’re not doing research, we’re just making ourselves feel better about buying this. That’s what confirmation bias is. What we’ve learned is that when we wanna buy a particular stock or bond or asset, we shouldn’t seek confirming information. We should seek disconfirming information, meaning, “All right, I want to buy this. Let me go out and find all the reasons why I shouldn’t buy this. What are the risks? What are the dangers? What else should I be looking at instead of this?” When we go out and try and disconfirm our beliefs, it’s a more objective, fair approach to doing research. If we turn around and say, “Hey, I can’t find a compelling reason not to buy this,” after you’ve done your disconfirming research, that’s a better decision than just sifting through all the stuff that’s out there and only reading the things that agree with your point of view. We all have this tendency to live in our happy little bubble, our happy little confirmation-bias bubble. We watch the same TV channels, we read the same things. We look for information that tells us, “You’re smart, you’re right. You’re doing this the correct way.” That’s not the best way, that’s not the most effective way to sift through news. You should be able to make the argument, pro or con, on every investment in your portfolio. If you can’t argue for and against it, you really haven’t done the research. When I was a kid, I used to watch “Mutual of Omaha’s Wild Kingdom,” and the show would open with this panorama of the African savanna and there’d be wildebeests and all sorts of creatures and zebras and gazelle’s. There was always that one gazelle on the outside of the pack, outside of the herd. And you knew what was gonna happen. There’s safety in numbers. There’s safety in the herd. When you’re by yourself, you eventually become somebody’s lunch. Humans evolved as social creatures. You know, a human alone in the jungle doesn’t survive very long. We don’t have fangs or claws or armor. By ourself we’re very vulnerable. But as part of a tribe, as part as a troop, we can be cooperative and help ourselves get along. That’s why we have a bias towards trusting other people, towards believing other people. Being a cooperative social primate, it’s really been enormously beneficial to us. Where that starts to hurt us in the market is when the crowd is starting to sell, when people start to panic, the hardest thing in the world to do is to go in the other direction. And so people talk about, “Let’s buy low and sell high.” Buying low means buying when most of your fellow you people are selling and your instinct is to go along with them, not lean against it. It’s really, really hard to do. So loss aversion is this interesting evolutionary development that we feel losses just about twice as intensely as we enjoy gains. And when you think about what that means, when the markets begin to wobble, when they sell off, it sends our bodies aflame. It makes us concerned that we’re gonna lose our money, we’re gonna lose our investments. And so loss aversion often leads us to make bad spontaneous decisions because, “Hey, we’re down 5%, we better do something, or we’re gonna be down 10%.” What we really need to learn is that markets are down 5%, you know, two, three times a year, they’re down 10% just about two out of every three years. Markets go up and down. Risk and reward are two sides of the same coin. And if you wanna be in it for the long term to garner the reward, you have to go through the risk, through the drawdown, through the difficult periods. And that’s where getting your loss aversion, at least understanding it, you may never be able to get under control, but understanding it and preventing it from affecting your decision making becomes really important. So the way anchoring comes up frequently in markets is someone will buy a particular stock and then turn around and suddenly the stock is a loser. It’s below what they paid for it. And I can’t tell you how many times I’ve heard this, “Please just let me get back to break even and I’ll get back.” People get anchored on that price. It affects how they look at the stock, how they look at the asset. We fixate on numbers and allow them to affect us. What you paid for a stock has absolutely zero relevance to where that price is gonna go. The question you should ask yourself is, “Hey, if I had fresh capital to invest, would I buy this stock at this price?” If the answer is no, it doesn’t matter what you paid for it, then get out of that stock. Perhaps the one that people pay the least amount of attention to but really should pay close attention to are just something as simple as politics. You know, we’ve seen studies when we analyze how a zip code has voted in a presidential election and then cross reference with that with how their portfolios are invested. This is all done anonymously based on just zip codes. Nobody’s names are involved in this. But it turns out that when your guy loses in the presidential election and most of your zip code voted for that guy, you have a tendency as a group to get outta stocks. And the reverse is true. When your guy wins and you’re subsequently asked, “How do you think the economy is doing? How is the market doing?” Suddenly your view of the world goes way up. It doesn’t matter who wins the presidential election. If you’re invested over the long haul, you’re gonna do better. In fact, studies have shown that whether a Democrat is in the White House or a Republican is in the White House, it really makes no difference to the long-term performance of the stock market. Presidents get way too much credit for when things go well. They get way too much blame when things go poorly. What really matters is the ability to compound over decades. And so that sort of tribalism, that sort of rooting for your team with your dollars never seems to work out well. The recency effect is one of my favorites. Every month we get a data point like nonfarm payrolls, and month after month, year after year, these come out in a string. They’re based on a model, it’s subject to revision, it’s kind of noisy. More or less it gets it right. Really, when you think about the data, why do we spend so much time paying attention to the most recent nonfarm payroll? Well, there’s 330 million people in America, about 165 million people in the labor force. Each month, 3, 4 million people leave their jobs. Some quit, some retire, some go on sabbatical or maternity or paternity leave. Some people just shuffle off this mortal coil and join the choir invisible. At the same time, another 3 or 4 million people start work. They graduate school, they switch jobs, they return from maternity leave or sabbatical. And the difference between those job quitters and those job starters, that’s essentially the nonfarm payroll report. How many new bodies are in the labor force and working over what that number looked like last month. So when you think about it, 50,000, 100,000, 200,000 people out of 165 million workers, out of 330 million people, it’s a really tiny number. And the model isn’t perfect. You know, the old joke is all models are wrong, but some are useful. So when we get the Bureau of Labor statistic data, really what we wanna know is, are we still on trend? Are we still operating within the same, more or less, parameters we’ve seen? Most of the time, the answer is yes. When we start to see things roll over, when we start to see the data change significantly from prior months, that’s when you pay attention and say, “All right, this looks like something significant is happening.” People live in the here and now, we exist in this moment, and what just happened very much occupies our minds. And so we have a tendency to overemphasize whatever’s going on in the market this day, this week. We tend to ignore long-term trends. We tend not to picture ourselves 10, 20 years in the future and what our needs are gonna be. This is just how we live. This is just the nature of of human beings. Whenever I wanna figure out the risk tolerance of a particular investor, I’m very cognizant that if the market’s going up, they tend to say, “Oh, I’m okay with risk. I’m a long-term investor. I’m aggressive.” If the market’s been going down for the past few weeks, the same person will give you a very different answer. You know, “I’m a little conservative. I’m a little averse to volatility and risk.” They’re not revealing their true nature. They’re essentially telling you what’s been happening. We have a tendency to overemphasize what’s just happened because that’s the moment we live in. We live in the here and now and it affects how we interpret everything that’s going around us. You know, we need to learn to be long-term greedy, to think about decades, not short-term greedy, thinking about the next 10 minutes.

– [Narrator] Chapter 2: Investing is a loser’s game. Here’s how to win it.

– So why do we even invest? We wanna put our money to work because 20, 30, 40 years from now, we’re gonna stop working and retire and we’re gonna need something to pay our bills. Most of us aren’t gonna be able to live on just social security. And so we put our money to work so that it’ll compound faster than the rate of inflation. And really it’s your job as an investor to not interfere with your portfolio’s ability to compound over that time. The loser’s game is a concept created by Charlie Ellis in a paper he wrote 30, 40 years ago. Eventually it became a book called “Winning the Loser’s Game.” And Ellis, legendary guy, chairman of the Yale Endowment, on the Board of Directors of the Vanguard Group. Ellis noticed that investing and tennis were both very similar in that they’re two games in one. There’s a winner’s game and a loser’s game. What does that mean? Well, let’s use tennis as Ellis’s example. There are two games in tennis, the game the professionals play, the top 0.01% of players, and then there’s the game the rest of us play, us 99.9% of the world who are amateurs. How do the professionals play? They play the winning game. They win by scoring points. They serve aces, they hit with power and accuracy, they kiss the line, they do fancy drop shots, lots of top spin. They keep the ball away from their opponent. That’s not how the loser’s game is played. That’s not how the amateur plays. How do us amateurs play? We lose through unforced errors. What sort of unforced errors? We double fault ’cause we’re trying to serve too hard, we hit the ball long, we hit it wide, we hit it into the net, we hit it right to our opponent. Instead of trying to play outside ourselves beyond our own ability, us amateur tennis players just return the ball, just keep it in play. Don’t try and kill it. Don’t try and hit the line. You are not skillful enough to do that. If you make fewer unforced errors and you let your opponent make those mistakes, you will win the loser’s game by making less errors. And so Ellis compared tennis to investing and he found something really fascinating. A handful of professionals, a tiny number of people, they can pick stocks and know when to sell them. They can identify which sector or country to invest in. They can time the markets. That’s the 0.01% of people. And they’re household names. You know who Warren Buffet or Peter Lynch is because they’re such outliers. The rest of us, we’re playing the loser’s game. We’re unfortunately underperforming because we’re making all of these errors. We get emotional, we overtrade, we don’t pay attention to costs, we ignore taxes. We make all of these mistakes that if only we avoided them, we would do so much better. That’s why Ellis thought investing and tennis were so similar. Most of us are playing the loser’s game and playing it badly. If we make fewer unforced errors, we would just be so much better off. So a number of academic studies have found that a surprisingly few percentage of stocks are actually driving market returns. Professor Hendrik Bessembinder at Arizona State University did a study and he found that just 2% of stocks are responsible for all the returns that we’ve seen over the past 75 years. Depending on the country you look at maybe it’s a little more, a little less, but it averages around 2%. How is that possible? Well, some stocks are up a little each year. Some stocks are down a little each year. Some stocks are flat. They all kind of cancel out. A handful of stocks are down a lot. Some stocks get crushed and go to zero. That leaves very few stocks that are the giant winners that drive returns. In the context of the loser’s game where we wanna make fewer mistakes every decision we make is another opportunity for error. And given how much the odds are stacked against us, if only 2% of stocks are driving most of the returns, what are the odds that we’re gonna pick that 1 in 50 stocks that’s gonna be a big winner? First, you have to identify a company that over the next 1, 3, 5, 10 years is gonna grow its revenue and its profits. That’s hard to do. Secondly, you have to buy that stock at the right time and at the right price. Overpaying for a stock isn’t gonna help you at all. Third, you have to be willing to hold that through all the ups and downs that company is gonna go through. Economic cycles, missed revenue expectations, missed profits. Stocks don’t go up in a straight line. They’re up and down. And sometimes when stocks pull back, it’s just a temporary setback and eventually they recover. Knowing when something is just pulling back temporarily or that its best days are behind it and it’s on the way down permanently, that’s a really difficult thing to do. Emotionally we have all these sunk costs in that stock. We’ve researched it, we’ve investigated it, it’s helped make us money. We’re loath to cut it loose because, hey, we’re tied up. It’s the endowment effect. “I own it, therefore, it has to be pretty good.” It’s very, very difficult to tell the difference between a Microsoft and an Intel both added to the Dow Jones Industrial 25 years ago. Microsoft has done exceedingly well. Intel not so much. How can you identify that in advance? Being added to the Dow is like, “Hey, you’ve made it.” This is the top group of stocks as decided by the editors of Dow Jones. And now when we look at the performance of these two stocks, they’ve gone in completely different degrees. The odds are stacked against you being a successful stock picker. And to put some numbers to that, let’s take a look at professional mutual fund managers. In any given year, less than half of them beat their benchmark, meaning they’re gonna do better than the market. So that’s telling us fewer than 50% are actually picking stocks better than just a boring, cheap index is performing. You take that one year and expand that out to five years, it turns out 80% of them fail to beat their benchmark. You take that to 10 years and it’s over 90%, net of fees and taxes, less than 1 in 10 mutual fund managers beat their benchmark. And over 20 years, it’s virtually nobody. And so understanding how much the odds are stacked against you as a stock picker is why indexing has become so popular these days. People have figured out, “I’m not gonna try and pick the next NVIDIA, I’m gonna buy all the stocks and that way I’m guaranteed to own that.” And it prevents you from allowing your behavioral errors to interfere with your portfolio. You are not selling a stock prematurely. You’re not timing the market. If you do regular dollar cost average, if you buy a chunk of stock, you buy a specific index every month, every paycheck, you’re guaranteed over the long haul to do better than 99% of your fellow investors. So when you’re thinking about putting money in the market, you need to have a plan. And I try and lay out a number of specific steps you can take really to prevent yourself from interfering with your money’s ability to compound in the market. So first step is to automate the process. Take the emotions out of it. With your 401k or 403b or whatever your tax-deferred saving plan is, you are making contributions every paycheck. If the market goes up, great. It means what you bought before is higher. If the market goes down, great. You’re buying more at a better price. Over the fullness of time that sort of dollar cost averaging, every paycheck every month, means that you are buying regardless and the math tells us that’s the most effective way to invest for the future. Nobel Laureate Paul Samuelson once said. “Investing should be boring. It should be like watching paint dry or grass grow. If you wanna have some fun, take $800 and go to Vegas and gamble. Don’t gamble with your portfolio.” Let’s talk about diversification. Investing is really a very humbling exercise. We all have to admit to ourselves we don’t know what stock, what commodity, what sector, what country, what asset class is gonna do best this year. You know, you get this quilt, this patchwork showing year by year what have been the best-performing sectors in the market. And it’s completely different year by year. One year, REITs are at the top of the league table. The next year, it’s tech stocks. The next year, it’s small cap value. It’s all but impossible to predict. And so rather than throw darts, rather than guess, we own a broad diversified portfolio. We own a little bit of everything. And that means you’re always participating in the sector that’s going up. You probably wish you had more of it this year, and then next year when it’s not doing well, you’re happy that you didn’t overload that particular sector. Diversification means you’re broadly participating in every asset class rather than speculating, rather than guessing. It’s the best way to make sure you own the best-performing assets. You know, Jack Bogle, founder of Vanguard Group, famously said, “Instead of hunting for a needle in a haystack, just buy the whole haystack.” You have to be aware of costs. That’s just simple math. The more you’re paying for a mutual funder and ETF, the more that drags on your performance. In fact, we’ve seen a number of studies over the years that over the course of 25, 30 years, a high-cost portfolio, everything else being equal, will generate 20% less value at the end of those 25, 30 years than a low-cost portfolio. A study on the Bogle Effect, Jack Bogle was the founder of Vanguard, that specializes in very low-cost funds. You could look at BlackRock and State Street are similarly low-cost funds are known for that. The Vanguard Effect has identified that by 2016, Vanguard fee pressure had essentially saved investors $1 trillion over the previous 30 years since Vanguard launched in the mid 1970s. Since 2016, over the next decade, it’s about another trillion dollars in fees that have been saved by the Vanguard effect. It’s that much more money in portfolios, it’s that much more money that’s compound and that investors own. And so fees matter a great deal. Go back to the bad old days of the 1960s and ’70s, mutual funds used to cost one, one and a half, 2 % of your assets. Some funds came with a front end load of 5%. In other words, you give the fund company $100 and they invest $95 of it for you. Think about what a drag that is on returns. And really the technology didn’t exist for us to understand this easily. People just saw the markets were going up from World War II to, let’s call it 1966, was a really substantial gain in assets. Nobody really focused on what’s driving these gains and what are the headwinds we’re up against. And then something similar took place in the 1980s and ’90s. We had a big bull market. Around the ’70s and ’80s was when we first started paying attention to the data as to the drag fees put on performance. So it’s not just mutual funds, it’s transaction costs. You know, it used to cost 3, 4, $500 to buy a stock. It’s free today. We deregulated the markets in the early ’70s and that allowed brokers to compete on fees. And we went from a few hundred bucks to a hundred bucks. I remember the commercials for the various online trading shops, $8 transactions. Eventually that became free trading. And so the cost structure of that is gone. And then when we look at what’s taken place with mutual funds and ETFs, it used to be one, one and a half, 2% to buy those. They’re well under half a percent today. You could buy a broad index like the S&P 500 or the Vanguard Total Market. It’s five bips. The cost is practically nothing and that just compounds in your favor. The lower your cost, the more you keep at the end of your investing life. You know, back in the bad old days, you would get a quarterly update of your portfolio, you’d get a statement and it was a big deal. Everybody sat around waiting for their statements to arrive and you would see how well you did. And that was probably too extreme in one direction. Technology has given us the ability to watch our portfolios second by second, tick by tick. That’s too far in the other direction. You should check your portfolio occasionally just to see how it’s doing. Monthly is probably plenty. If you are concerned about something in particular and you start noticing yourself checking your portfolio more frequently, sometimes that’s a little bit of an alert that, hey, maybe you have too much risk on and you’re too concerned about your exposure, or maybe we’re entering a period of market volatility and that’s gonna create an opportunity for you to buy stocks at a cheaper price. People talk about the importance of rebalancing. Let me give you a little context of what rebalancing means and how you should think about it. The idea is that stocks go up over the long run. And so if you have a portfolio that, let’s say, is 70% equities and 30% bonds, in the event of a market sell off, hey, maybe you end up 60% equities and 40% bonds because of how those two asset classes have moved. What we suggest to people is that they rebalance into equities. You sell a little bit of the bonds that ran up, you buy a little bit of the equities that ran down. And essentially what you’re doing is selling bonds high and buying stocks low. It’s sort of counterintuitive. The time to rebalance into equities are when we have these deep market corrections or drawdowns, down 20, 30, 40%. That’s where you wanna engage that. Most of the time you shouldn’t really be worrying too much about rebalancing. I don’t think it’s that important for the average investor’s portfolio. So, “Nobody knows anything,” comes from William Goldman, who was a screenwriter in the ’60s, ’70s, ’80s. And he wrote a pretty scathing confessional about Hollywood and how bad executives in the various studios were at predicting which films would do well. Almost all the studios passed on “Star Wars,” on “Raiders of the Lost Ark,” on “E.T.” And it’s only when one random person says, “All right, let’s give this a shot,” that some of these movies go on to become blockbusters, despite most of Hollywood not thinking there was anything there. Taking that same concept to the world of forecasts. Forecasts are when a market professional or expert or talking head or pundit says, “I believe this asset class will be this price at this time.” Specific assets, specific time and date, specific price. And when we look back through the history of expert forecasts, it turns out that the experts are no better than any of us. Wharton professor Philip Tetlock did a study on this. He looked at thousands and thousands of forecasts. He found they were no better than the average person’s prediction. And the average person’s prediction’s pretty bad. Just take a look at the past few years. Heading into 2020, nobody had a pandemic closing the economy. Oh, and by the way, from March till the end of the year, the market’s gonna rip up 69%. That wasn’t in anybody’s forecast. Nobody had the Russian invasion of Ukraine in 2021. 2022, nobody had the Federal Reserve raising interest rates 500 basis points, sending stocks and bonds down double digits. That’s a very rare occurrence for stocks and bonds to both be down that much in the same year. Hadn’t happened for 40 years. And so it turns out the future is just so filled with random events and unanticipated things occurring that making forecasts out a year, it’s really a fool’s errand. And if we make our investments based on these forecasts, we’re really destined to do poorly. We have to be aware of our market timing and becoming fearful and emotional every time the market has a pullback. We look at the history of markets, they’re down 5% twice a year, they’re down 10% two out of every three years, and they’re down 20% fairly regularly. If you respond to every time the market twitches, you’re gonna prevent your portfolio from compounding over time. We think we could time markets. Here’s the fascinating thing about news and market timing. Markets are pretty efficient. You know, they’re not 100% perfectly efficient, but if you’re seeing something on a website, on TV, in a newspaper, the odds are that every other person with capital at risk in the markets has not only seen it, but acted on that and that news is already reflected in stock prices. So you see the cover of a magazine or the headline in “The Wall Street Journal,” that information is already in the price. To imagine that you’re gonna read that and then act on it in a way that’s gonna be beneficial to you, you’re essentially trading on old information. I know we call it news, it’s news to you, but it’s old to the market. What studies have shown us about people who sell when markets make a low, in other words, they panic sell into a crash. About 30% of these people never return to equities ever again. That’s an amazing statistic. Think about what happened when people panic sold January, February, March, 2009. The market has had an incredible run over the next 15 years, and nearly a third of people who sold into those lows never got back into equities. That’s devastating to a portfolio’s performance. Avoiding these unforced errors, having a plan and sticking to it, that’s the secret of winning the loser’s game.

– [Narrator] Chapter 3: how financial media sets investors up for failure.

– So the financial media business model, people seem to think it’s selling content, selling news, selling analysis. That’s completely wrong. The model is the media sells an audience to advertisers. In other words, they’re not selling content, they’re selling you. You aggregate all these viewers, readers, listeners, watchers, and you sell them to a buying audience of advertisers. The problem with this model is that it has been under assault from technology for 25, 30 years. The brutal competition in the marketplace has forced a lot of media to become increasingly, for lack of a better word, histrionic. Very, very clickbait type headlines. They know that they’re now competing with algorithms on social media. It’s become increasingly sensational and not just in the way it was sensational a century ago. It’s driven by algorithms. We’re checking multiple headlines to see what gets the best response. We know how TikTok and Instagram’s algos work. They’re constantly running through millions and millions of users. They’re identifying what’s gonna keep them engaged longer. And so it’s not about providing news or information, it’s about whatever holds your attention. We are in the attention economy. And what this means is we think of media generally as providing a service for us. In reality, we are the service for them. We are the crop that they harvest and sell for advertisers. What’s so important and so dangerous about this to us as consumers is that everything is presented as an existential threat. The one that I saw about 10, 15 years ago started getting emails over and over again, “New York Stock Exchange margin debt is at an all time high.” That makes me nervous. And I don’t know who was spreading this news, but after you get the third email from a client saying, “Hey, what do you guys think about this?” Well, you go back and you research it. What is margin debt? Margin debt is the ability to borrow against the value of your stock. I’m not a big fan of people borrowing against their portfolios to go spend their money elsewhere, but it’s a data point that everybody seems to track. As it turns out, that the higher the stock market goes, well, there’s more value for people to borrow against. It doesn’t give you any information about what the market’s gonna do in the future. Where are we gonna go? The state of the economy. high margin debt just tells you stocks have risen to the point where there’s more value to borrow against. And so we have to be able to put what happens on a random Thursday in 2025 into context for, “What does this mean if I’m retiring in 2040 or 2050?” Most of the time it’s pretty meaningless. But because it’s such a relentless fire hose of noise and distractions, they know how to push our buttons, they know how to get you excited, and we’re wired for this. Good news slips by, nobody really pays attention. My favorite example is it took the newspapers something like 15 years to really talk about flying after the Wright Brothers first achieved heavier-than-air flight. It’s kind of an amazing thing. Think about how flying has changed the world. Eh, it really didn’t matter. On the other hand, every piece of bad news, every terrifying statistic, every potential war, every threat to the economy, it attacks us at a visceral way. We are primed for bad news and bad news primes us towards our bias to action. Most of the time, those actions are contradictory to our best interest in the markets. You know, the old joke on the trading desk was, “Don’t just do something, sit there.” Meaning don’t follow every twitch, every news story, every TikTok, every Instagram, don’t interfere with your portfolio’s ability to compound. Yet we’re hardwired to make that mistake. It’s kept us alive on the savanna for millions of years and allowed us to become the most successful species on the planet. It just doesn’t work very well when you’re trying to figure out your asset allocation or which municipal bond portfolio to buy. So let’s talk a little bit about how the media abuses numbers. Most of the time you’ll get a big scary number and it’ll be out of context. There’ll be no framing or context to explain what that number is. My favorite example is, “The market was up 500 points today” or, “The market dove 500 points.” Which market? Is that the S&P 500? Well, that’s a huge move. That’s a nearly 8% move. That’s very, very worrisome. Is it the Dow Jones? Well, if it’s the Dow, it’s less than 1%. That’s a normal trading range. We see it in economic data all the time. “This firm laid off 10,000 people.” Is that a lot or a little? I can’t answer that question unless I know how many people work for that firm. If it’s a regional manufacturer with 25,000 employees, well, 10,000 people laid off is giant. If it’s Walmart with over 2 million employees, that’s like one person quitting every fifth Walmart store. Not very significant. And so there’s literally a technical term for this. It’s called denominator blindness. It’s when you get the change in numbers plus 5%, minus 100, whatever it is but you don’t get the context, don’t get the framing, you don’t get the denominator, the bottom half of the fraction. My favorite example of big scary numbers wildly outta context came along this summer. It’s the 50th anniversary of the movie “Jaws.” I was a kid when “Jaws” came out. People were terrified to step in the ocean. But when you look at the dangers of sharks, and the media certainly played that up all summer, it turns out that shark attacks are exceedingly rare. There were about 50 shark attacks last year worldwide. One fatality in 2024, 2 in 2023. Most of the time there’s a shark attack, it’s a surfer in a black wetsuit. To a shark they look like a seal and they’re just taking a bite. When it turns out that it doesn’t taste like a seal, they tend to move on. That gets reported everywhere. What doesn’t get reported? It turns out in the United States, more people died last year falling out of bed than were killed by sharks. And you don’t get that sort of context, you don’t get that sort of data from the media. They like things that are big, exciting, emotional, and scary. Sharks were tailor-made for the media. People dying rolling outta bed? No one could be bothered with that. It’s not scary or exciting enough. We want confident leaders who are gonna tell us what’s gonna happen, and here’s what we need to do to survive. So when we flip on the TV or open a website, and there are two people debating where the market’s gonna go, someone who’s really specific and precise, “Next year the Dow is gonna be 53,575,” not only do we wanna believe them, we tend to believe them. The person who’s more ambiguous, “Well, a year is a really long time. So many random events can happen. Markets on average give us 10%. Hey, if there isn’t any other geopolitical problems or issues with inflation or consumer spending, maybe we’re eight or 10% higher. But who really knows?” Everybody hates the honest answer, “I don’t know.” And they really like the specific answer. Studies have shown us not only do we tend to follow the person who’s being very specific, that person tends to be wrong much more frequently than the person who says, “Really, we don’t know where the market’s gonna be a year from now. But on average, 8, 10% seems to be a reasonable forecast.” So I’m in an odd position to be criticizing the media because I’m both a producer of news and content and a consumer of news and content. I’ve been writing publicly for 25 years. My blog, The Big Picture, is where I started. I wrote a personal finance column for “The Washington Post” for a number of years. And for the past decade, I’ve been writing for “Bloomberg” as well as hosting a podcast “Masters in Business.” So I’m very conscious of the content I produce. I try not to engage in the sort of recklessness that I see. I don’t wanna give a person a fish, I want to give them the tools, teach them to fish so they can be better investors. So that’s a a little bit of a twist that I’m on both sides of it. As a consumer of news, I have a set of rules that I follow. It’s not that I pay attention to any one masthead, publication, newspaper, television show, et cetera. I pay specific attention to the people who have demonstrated that they’re worthy of my attention, that they’re value add. And what those qualifications are is, first, temperament. I wanna follow someone who’s fairly cool and calm. I want them to have a defendable, repeatable process, right? As opposed to someone who just got lucky once. I want them to have lived through a few cycles. Having lived through it a few times, they have an expectation of what’s most likely to happen over the long term. And finally, I want them to have an expertise and to add value to a space where I don’t have an expertise. I wanna learn from people who understand market structure or are experts in ETFs, who understand real estate, who’ve analyzed the economy or inflation and bring some value to the table. Not because I’m gonna change my portfolio in response to these things, just because it brings me a little bit more understanding of what’s going on in the world. The world is nuanced and there are shades of gray. It’s not just everybody is terrible and everything you see is awful and just shut everything off. That would be an easy solution. What makes it challenging is that so many people that are in the media, on TV, host a Substack or a YouTube channel, have something valuable to offer. You have to ask yourself when you’re paying attention to these people, “Is this a person that should be on my all-star team?” I always ask myself, “Who is this person? What are they selling? What conflicts of interest do they have? And what’s their track record like?” And then their advice, I always have to ask myself, “Is this advice suitable for me? This person doesn’t know my income, my savings, my tax rate. Should I really be paying attention to their advice?” And always ask yourself, “What are the opportunity costs for tying up money in this investment when I could just be following my plan and that I have a high degree of confidence will work out over the long term?” If you want to give them your money, my suggestion is always make sure they’re a fiduciary. Make sure they’re legally obligated to put your interests first. So I’ve been critical of regular media, but when you move towards the realm of social media, it’s a whole nother level of incompetency, bad information, grifting, and just simply dumb advice. At least traditional media has gatekeepers and editors and someone saying, “Hey, can we really say that? That seems to be outrageous and wrong.” There’s no such gatekeepers on social media. I find it really fascinating to delve into some of the worst aspects of this. One of my favorite accounts on Twitter is called TikTokInvestors. And this person, who is an anonymous investing professional, goes out to TikTok and Instagram and Facebook and finds the dumbest, worst advice they can find and shares it on Twitter. And some of the stuff is just hilarious. The one I noticed most recently was, “Here’s how you turn a hundred dollars into a million dollars. All you need to do is follow my advice and just make 1% a day. 1% a day compounded for 250 trading days is $1 million and it just costs you $2,000. Sign up for my newsletter.” Stop and think about how ridiculous the math is there. The average return for a professional mutual fund manager or ETF manager underperforms the market, which gives us about 10% a year. More than half of professional mutual fund managers underperform their benchmark each year, and that benchmark is about 10%. To imagine that you’re gonna compound at 1% a day for 250 days is just ridiculous. The tell is, “Subscribe to my newsletter. It’s only $2,000. I’ll share the secret.” The reality is, if you had a secret of turning a hundred dollars into a million, why would you sell that to anyone? Why wouldn’t you just turn a hundred into a million and then a million into a hundred million? If it’s that effective, shut up and deploy your own capital. But the reality is, when people are selling you something, it’s because they cannot achieve what they’re promising. And the way they’re gonna make money is through your subscription dollars. It’s not just investing, it’s real estate advice, it’s career advice. Tax advice is one of the most outrageous things we see on TikTok and elsewhere. It’s gotten so bad that the Internal Revenue Service had to produce a list of 47 pieces of advice found on social media that are wrong, that will lead to interest, penalties, and in some cases, jail time. Know if you’re in international waters on a boat on April 15th, that doesn’t mean you don’t owe taxes. Some of the advice that’s given is just absurd, unsupported. Nobody is vetting these people. The fact that the IRS had to put out a document saying, “All this advice is terrible and costly,” tells you just how bad the sort of Wild West of social media can get. So to sum up, you need to have self-awareness. You need to understand the sort of errors we all make. It’s not that you’re dumb, It’s not that you’re a bad investor, you are a human being and you succumb to the same cognitive errors, the same mistakes, that all of us make. And so you wanna prevent your brain from getting in the way of your portfolio’s ability to compound. And the way you do that is you have a financial plan. It’s a diversified portfolio of broad assets. You allow it to compound over time. You automate the investing process and then you check it in frequently and just stay out of your own way.