The bowling alley of investing
November 29, 2019
Beyond the pure Americana of it all, the beautiful thing about bowling alleys is the gutters. No matter how badly I roll that colorful sphere, I know those gutters will prevent me from wiping out my neighbors' games. I'm confident when my son throws overhand with his mini-ball, it will all be ok.
There is a way to throw a strike in investing. We believe, at least based on data from 1926 forward, that we have a good idea of the line the ball has to follow to knock out the pins. We also know that line is one few Americans are going to follow.
This isn't just a hunch. Perhaps my favorite investment study confirms it. Dalbar Research tracks American equity investors over a 30 year time period. Of every eight dollars of market return over that period, the average equity investor received one. This was due to excessive financial fees as well as investor behavior.
In other words, even if an investor knows exactly what should be done, there is little chance he or she will do it over a long period of time. It's human nature to let other emotions in the door.
Back to the bowling alley. We know that, from time to time, you may want to pick off an end pin instead of going for a strike. Maybe it's just that thrill of getting the ball right on the edge of the gutter. So we'll try to work with that, as long as it's within the general guardrails of a strong framework.
To give you a sense of the behavioral errors we are looking for, here is a partial list from Dalbar:
- Loss Aversion: disproportionate fear of loss.
- Narrowing Framing: making decisions without flushing out all implications.
- Anchoring: Relating events to familiar experiences, whether appropriate or not.
- Mental Accounting: taking undue risk in one area to avoid rational risk in others.
- Diversification: seeking to reduce risk, but simply using different sources.
- Herding: copying the behavior of others.
- Regret: treating errors of commission more seriously than errors of omission.
- Media response: reacting to news.
- Optimism: belief that good things happen to me, bad things to others.
Our job is to consider emotional factors in investing as much as those which are numerical.
Have a nice remainder to your holiday weekend.
Dan Cunningham
Dalbar 2018 Release
