Some Thoughts on Thinking

The ability to think clearly and draw correct conclusions is necessary in everyday life, especially when it comes to making important decisions. But thinking critically is not natural; it’s not the way our brains are hardwired. Instead, we are hardwired to follow the path of least resistance, which often results in hasty and suboptimal decisions. This is especially prevalent when uncertainty, anxiety, and emotions are high.

Assumptions: Necessary, But Unreliable

Because we seldom have full information, we must rely on assumptions to fill in the information gaps. These necessary, but often spurious assumptions can cause flaws in our thinking and judgement. If information seems plausible, especially if it is part of a good “story”, our brains will accept it as fact and move on.

As investors, we may assume that an “expert”, who has a lot of experience and is a frequent contributor on financial shows, knows what will happen and has our best interests at heart. We also unconsciously (and falsely) attribute one’s confidence with one’s ability to correctly predict the future. As much as we wish it were true, it’s not.

Even when we have full information, we still don’t know how others will respond – such as with the global shut down. Who would have thought the market would tread higher even as countries and economies shut down?

Critical Thinking is Critical for Investors

We are not born to be critical thinkers, just like we aren’t born to be great musicians. It takes effort, time, and practice. Critical thinking requires us to:

  1. Seek all available information – not just the information at your fingertips
  2. Play devil’s advocate – what if the opposite is true
  3. Challenge pre-existing opinions/conclusions

Cognitively, critical thinking is hard; it is draining. Which is why our thinking often defaults to the path of least resistance. And this is why you have us. We will do the heavy lifting. Thinking critically about the economy, markets, and your options are essential to making wise decisions. It may not be natural nor easy to think critically, but together we can ensure your financial decisions are thoughtful and in line with your plan.

©2022 The Behavioral Finance Network

The Holy Grail of Investing

Most investors would love to find the Holy Grail of investing – an investment that provides great returns with very little (or no) risk. Many investors consciously acknowledge that such an investment doesn’t exist. But we may still be attracted to that investment because of how badly we wish it would exist. And sometimes hope and desire, unconsciously, overrule logic and rationality.

A Recent Example

A few years ago, a mutual fund was created specifically for investors who were uncomfortable with volatility. The fund marketed itself as one that would “harness volatility” and “make volatility your asset.” It also claimed to be uncorrelated to traditional stocks and attempt to achieve both capital preservation and growth. Sounds like a real winner!

As you can imagine, money poured into this investment. It was marketed as the perfect investment for those concerned about volatility. It did well for a while, but just a single week of increased volatility blew the entire fund up. All the money was lost in less than one week! Ironically, volatility, the event the fund was going to “harness,” caused the fund to blow up.

Looking Forward

As investor concerns grow, we can expect that someone will create an investment product or strategy to “solve” the concern. Based on current headlines, we could see investments that claim to prosper during periods of inflation, stagflation, or “overextended” markets. No matter the concern of the day, we can reasonably assume the marketing will be very good – an emotional appeal to alleviate our concerns.

Our emotions and unconscious desires often inhibit skepticism and reasoning. Acting on emotions is the natural first response for many of us. It’s just the way we are hardwired. Thinking logically takes effort. That is why you have us. Together, we can ensure that your investment decisions are free from emotion, unconscious influences, and in line with your plan.

©2022 The Behavioral Finance Network. Used with permission.

Investing Amid Uncertainty

Investors express discomfort when things are uncertain. This is especially true when experiencing “heightened uncertainty,” such as with the current Eastern European conflict.

However, uncertainty is not just a circumstance of economic and investment markets, it is a fact of life. Our future, by definition, is uncertain. There are times when the future is less uncertain (the sun will rise tomorrow), but there are seldom, if ever, guarantees of future outcomes. In other words, life happens in probabilities. Learning to consider probabilities in our decision-making process will help us become more comfortable living with uncertainty.

The Probability Problem

The greatest challenge to thinking in probabilities is that it is just not natural. While gray matter fills our brains, they hate gray areas. They want to think in terms of certainty and will often convert a probabilistic scenario to either “will happen” or “will not happen.” An 85% chance of rain? The brain defaults to, “it’s certain to rain.”

When it comes to investing, we often hear terms such as “risk on” and “risk off” as if investing is just a switch. Investors similarly think in terms of “all in” or “all out.” This type of binary decision-making is natural, easy, and reinforced by the media. But it may lead to costly investment decisions.

Investing Probabilistically

Investing probabilistically is about adjusting your allocation, rather than making a significant move that amounts to a bet on which way the market will go. When the perception of the risk/reward balance is unfavorable, a small shift to safer assets is in order. And vice versa when the risk/reward balance is more favorable.

Because we cannot divine the future, the correctness of an investment decision should be based on strategy and probability, not the outcome. A good practice is to stop guessing what the market will do in the future. It cannot be known. Instead, consider making probabilistic adjustments proportionate with your risk tolerance. That will help you become more comfortable investing amid uncertainty.

©2022 The Behavioral Finance Network

The Challenge of Selling

Selling a security is something that investors ponder from time to time. Whether that security is an individual stock, a mutual fund, or an index fund, investors are left with the question of what to do with the proceeds.

No matter the reason for selling, it is important we have a well-thought plan for what we will do with the proceeds…before we pull the trigger.

Remaining in Cash

The default for selling securities is to remain in cash. Whether the markets are high or low, we may justify sitting in cash until the “uncertainty and tough times pass.” This logic relies on a significant (and incorrect) assumption – that there will be an all-clear signal that it is a good time to invest.

Sitting in cash may seem to be a comfortable and safe move, but it is fraught with uncertainties and long-term danger. When do we get back in? What if the market keeps moving higher? At what point do we realize that the train has left the station and we aren’t on board? 

Investing in Another Security

We may sell a security with plans to invest in a different one. Sometimes we are influenced to buy a security that has been performing better than what we own. The question we must ask ourselves is: “What evidence do I have that the new security will perform better than the existing one?”

This is an important question to reflect and discuss. A lot of money has been lost because investors sold and bought at the wrong time. This happens with both novice and professional investors, including institutional managers.

In a study spanning 24 years, researchers analyzed the trading results of institutional money managers. They found that the stocks they sold subsequently outperformed the stocks they bought at a cost of over $170 billion. The abstract summarized, “Plan sponsors could have saved hundreds of billions of dollars in assets had they simply stayed the course.”1

Thoughtful Selling

Of course, there are occasions when selling a security makes sense. But that should only be after purposeful thought and a plan of “what’s next” is created. It is so easy to sell, and our emotions can sometimes get the best of us. But that is why we are here. We’re here to help ensure your decisions are thoughtful and in line with your plan.

1. Scott Stewart, John Neumann, Christopher Knittel & Jeffrey Heisler, “Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors”, Financial Analysts Journal 65, no. 6 (2009)

©2022 The Behavioral Finance Network

A Dependable Forecast for 2022

Most investors love economic and market forecasts. With the markets so uncertain and volatile, our brain craves some sort of idea of what the future holds. But the markets are unpredictable – evidenced by the fact that no one can consistently predict them with accuracy. Of course, a certain forecast will be right from time to time, just like a broken clock. But market forecasts are not dependable, no matter what your brain tells you.

Unlike market and economic forecasts, our forecast is reliable and robust because it is based on enduring investment truths and investor behavior. These factors are more dependable than market outcomes and more important to an investor’s well-being.

Our 2022 Forecast

In full disclosure, the following forecast is nearly identical to our forecast for 2021 and years prior to that.

• The economy/market will do something that surprises us but will be obvious in hindsight

• Investors who watch the market often will experience more stress than those that don’t

• You will be tempted to change your investment strategy based on market performance, expert forecasts, and/or your personal beliefs about the future

• Your investment decisions and reactions to market events will have a significant influence on your personal investment return

• Investors that focus their time and attention on those things they can control will have a better investment experience than those that focus on what they wish they could control

Conviction, patience, and discipline are virtues every investor should develop. They aren’t easy, yet they are essential for your success. As your advisor, one of our most important roles is helping you ignore the noise and focus on what really matters to your financial success.

We wish you a prosperous, fulfilling, and happy 2022. Thank you for allowing us to be your trusted partner along the journey.

©2022 The Behavioral Finance Network. Used with permission.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.

Tis the Season of Forecasts

Every December we get inundated with forecasts for the following year. These forecasts range from expected GDP and interest rates to stock market performance.

We are naturally attracted to forecasts because they purport to tell us what is going to happen, and they often are supported by persuasive reasoning and statistical analysis. After listening to a confident and persuasive forecast, especially if it is one we hope will come to pass, we may be inclined to make changes to our investment strategies in line with that forecast. But herein lies the mental deception. While forecasts appear to reduce future uncertainty, that is only an illusion because the markets are simply unpredictable.

Over the past 20 years, when polling economists and market strategists as a group to come up with a consensus forecast, not once did they forecast the stock market would be down the following year. Yet, we experienced six negative years. But that is not all. Experts predicted several recessions that never occurred and have been predicting a bubble for the last several years.

When it comes to forecasting the market and economy, it’s not so much about someone’s experience or knowledge. It’s about the predictability of the event. The market is impossible to predict because the future, by definition, is uncertain. Unexpected events (life happens), our responses to world events, and randomness make accurately forecasting the markets an impossible task. The proof is in the fact that no one can do it – consistently.

Not all forecasts need be ignored. Some are better than others. Forecasts that offer a large range of potential outcomes can be helpful in setting our expectations for the future. Creating a vision of what is possible in the future is much more beneficial for our planning and decision-making than a specific forecast. Remember, the more specific the forecast, the more likely it will be wrong.

We read and review many forecasts that are published. We look forward to sharing with you in the coming weeks our thoughts along with productive expectations and perspectives to help us have a great 2022, no matter what the markets may do.

©2021 The Behavioral Finance Network

The Wisdom of Ignorance

It may seem like a misnomer to discuss the wisdom of being ignorant. Ignorance, defined as a lack of knowledge or information, is not viewed as a positive attribute. But it is essential for our individual success – both financial and psychological.

We are ignorant to how cell phones transmit a voice instantaneously across the globe to another person. We know that when we take medicine it will make us feel better, but we are ignorant to how the pill interacts with our cells to make it all happen. We are grateful other people know this so we can benefit from their knowledge. If we were not ignorant about certain things, we would not have the capacity to become an expert or specialist in other things.

There is simply too much information for us to process everything. Selective attention and ignorance not only make the economies function, but they make us all need each other. We value each other and are grateful for others’ expertise where we are ignorant, and vice versa.

When it comes to investing, ignorance truly is bliss. The news story of the day, the quote of the hour and the unreliable predictions do not help investors achieve better results. To the contrary, studies have shown that investors that pay attention to such fleeting information trade more often and achieve lower returns.1 In addition, the constantly changing market information produces greater stress and anxiety, which may weigh heavily on our personal lives and relationships.

As we come upon the Thanksgiving season, we are grateful that we have a choice of what we pay attention to and what we ignore. We cannot control the volume, frequency, or insanity of information, but we can choose what we allow in our minds.

With investing there is always something to worry about; always has been, always will be. But that is your choice. We have not heard of a single person, on their death bed, who wished they would have watched the market more often. Be wise by exercising ignorance in those things that detract from your happiness and focus your time and attention on what really matters.

  1. Dalbar, Inc. Quantitative Analysis of Investor Behavior

 

©2021 The Behavioral Finance Network

Climbing A Wall Of Worry

It is often said that stock markets climb a wall of worry. This makes sense since historically the market has gone up and there always seems to be something to worry about. 2021 is no exception. Year-to-date (through September), the S&P 500 is up about 15%. Strong stock performance despite the Delta variant, extreme political partisanship, debt and inflation concerns. 

Investors worry about volatility, and we even worry when there isn’t volatility such as in 2017. Absence of volatility may make us concerned about complacency or what we might be missing.  In other words, there is always a reason for investors to worry about something.

Worry is an interesting concept. Present worries trump anything in the past because we are living and working through it. The uncertainty and anxiety are felt today. This may cause us to overweight current concerns and result in a myopic, rather than long-term, view of the future. For long-term investors, it is advantageous to maintain a long-term perspective.

Concerns – Past & Future

What did investors worry about in 2019? How about 2018? The stock markets were negative in 2018, so we probably worried a lot. But we can’t remember. That is because worries tend to work themselves out. We adapt and adjust to our changing circumstances, especially the bad ones.

What will we worry about next month or next year? It could be a continuation of present concerns, or it could be something entirely different. But it will be something!

In our experience, we have seen that investors who focus on the “worry of the day” experience greater stress and are more likely to make an unwise investment decision. Worrying is part of the markets. It’s not worth the psychological or financial cost. 

If you have any concern, please let us know. One of our greatest values is to help you know what is worthy of your attention and concern and what should be ignored.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly.

Creating a Virtuous Cycle

There are many concerns today that can significantly affect our thoughts, actions and quality of life. Fires out west. A devastating hurricane in the south. Afghanistan. COVID. The list could go on and on.

There are many things that are beyond our control in life. However, we can choose to focus on those things we have control over.

This is a great time to create a virtuous cycle to help us remain focused and become our best selves. Creating a virtuous cycle is empowering and enduring. It often results in greater contentment and success in our lives. It is an upward spiral of potential and progress.

A virtuous cycle is a product of our choices. It is not dependent on good luck nor avoiding bad outcomes. The following three tips can help you create your own virtuous cycle:

  1. Surround Yourself with Great People. We tend to take on attributes of those we associate with. These social connections influence how we think, feel and behave. It’s easy to be negative and a cynic; much more difficult these days to be an optimist – that is a gift.  Choose to be around positive people and allow their perspectives and disposition to rub off on you.
  2. Praise Others. Be liberal with complimenting others and slow to criticize. In our day this is much easier said than done. Direct praise (you are a great friend) is much better than comparison praise (you are a better friend than Linda). Combine gratitude with praise for the optimal effect (I appreciate how you listen and give me good advice). Direct praise increases another’s self-worth and your individual potential.   
  3. Avoid Negativity. We don’t always agree with others. Everyone has virtue and shortcomings. We can choose to focus on positive qualities of others (and ourselves) rather than their flaws. 

Circumstances may influence us, but they don’t have to compel us. We can choose to act positively, rather than be acted upon by negative externalities.

The Virtue of Slowing Down

Time is an interesting dimension. It is a fixed measurement, yet our perception of time varies greatly depending on what we are doing.

It has been said that the longest eight seconds in life is riding a bull. We never rode a bull and have no interest in testing that statement. So, we will take it as fact. But even so, eight seconds is eight seconds – regardless of what we are doing.

It’s About Perception

Time seems to “fly” when we are engaged in a fun, exciting or stimulating activity. And it appears to stand still when we are scared, anxious or bored. In other words, the things we enjoy in life make it “go” quickly, while the things we dislike seem like they last for an eternity.

This means that when we are engaged in desirable activities, such as summer vacation with the family, it may be worthwhile to take a moment to slow down and reflect on the experience. This will allow us to relish the moments and the subsequent memories – which we can call upon during the more difficult times. 


Slowing Down & Investing

Slowing down can also help us make better financial decisions. When information comes at us in an orderly rate, we can process the information just fine and draw logical conclusions. But when we get a ton of information all at once, our brain freezes – just like a computer when trying to process many things at once. 

When the brain freezes, it can no longer process information and think critically. That part of the brain is offline. If we require a decision right away, the brain will transfer the decision-making to our impulsive brain. That means our decisions will be more influenced by intuition and how we feel rather than thoughtfulness.

One of the things we love most about being advisors is helping clients decipher what information is worth considering and what isn’t. We’ve found that makes decision making easier, and can greatly improve the overall investment experience.