Confirmation Bias Illustrated


Please watch the video here (it can’t be embedded) and thank me later.

“Like, I’m listening to what you’re saying but I only hear what I want to.”


A Behavioral Finance Playlist

It isn’t “Weird Science” (Oingo Boingo)…

…or “Brain Damage” (Pink Floyd)…

…or even “Insane in the Brain” (Cypress Hill).

It’s utterly human (and I write about it often). We are all deeply flawed. We have inherent flaws and weaknesses that impede good judgment and good behavior. Behavioral finance has done a pretty good job outlining these foibles and music does a great job demonstrating them. So let’s get started with our Behavioral Finance Playlist.  Continue reading

Chris Rock Explains Bias Blindness

When the nominations for the 88th annual Academy Awards were announced this past January and for the second year in a row included no minority nominees for any of the major performance categories, my first thought was here we go again. But my second thought was that Chris Rock would be hosting the Oscars’ award ceremony and that there might be fireworks.

I was not disappointed. Rock quickly let it be known that he would not be boycotting the ceremony (as he quipped during his Oscar monologue, “How come there’s only unemployed people that tell you to quit something?”) but also that his opening monologue would be addressing the #OscarsSoWhite controversy in a big way.

He sure did.

Continue reading

The Jewelry Effect

Bass LureI’m not a fisherman, but I was fascinated recently to come across an article about the science behind the creation and use of fishing lures. Size, shape, color and even taste all matter. Interestingly, however, there is a surprising degree to which the effectiveness of the lure doesn’t matter commercially. For example, there is a dizzying array of bass lures in variations of blues and purples (see at left, for example) even though bass cannot see those colors as anything other than gray. But people buying lures seem to like those colors. Those involved in the research and sale of fishing lures refer to this phenomenon as the “jewelry effect.”

“We design lures for the fish, but fish don’t buy lures,” says Keith A. Jones, a director of research for an Iowa lure-maker. “It’s hard to convince anglers that a lure’s color doesn’t make much difference.” Scientific reality doesn’t even get much respect in the fishing world.

Jones recognizes that, to be commercially successful, lures need to be aesthetically pleasing to the people who buy them. Accordingly, some lures that work well need a design change to sell. Ted Dzialo, executive director of the National Fresh Water Fishing Hall of Fame and Museum in Hayward, Wisconsin, simply captures the essence of the issue. “I think most lures are designed to catch more fishermen than fish.”

If this sounds remarkably similar to the money management business to you, you’re not alone. So-called “smart beta” is really good marketing because it takes advantage of demand for beta-driven solutions but it is no panacea. Moreover, “factor investing” can trace its origins back to at least Benjamin Graham and is hardly new to smart investors. After the financial crisis, consumers rushed to money managers offering tactical management in order to try to avoid the next big downturn even though there is precious little evidence that it works. And hedge funds continue to lure major assets and major investors – perhaps because those investors want to prove to themselves and others that they’re rich – even though hedge fund performance has been, in two words, truly dreadful.

There are plenty of other examples, of course, but you get the idea. Good investing is necessarily a long-term enterprise and we humans struggle badly with the long-term. The short-term is too alluring. Our efforts at hyperbolic discounting generally suck. Thus we are always prone to eat the cake and skip our work-outs.

Those who market money management are well aware of these tendencies. And, to be fair, there isn’t much that’s sexy about good money management. We want the next Apple rather than diversification. We want to avoid the next big crash but every last drop of upside. We want to get rich quick and think we’re smart enough to find that next big thing. But we are routinely disappointed and, when we think we’ve (finally!) found the Holy Grail, it turns out that Holy Grail Investment Management is run by Bernie Madoff.

Most money management firms set out first and foremost to lure and catch investment dollars and only secondarily to manage the assets won effectively. The jewelry effect is at least as prevalent in money management as in fishing. But pretty it’s not.

A Hierarchy of Advisor Value

I talk often with lots of advisors of all sorts and from a wide variety of firms. They are profoundly disillusioned an astonishingly high amount of the time. When the markets are strong, they are disappointed that they didn’t capture enough of the upside. When the markets are weak, they are apoplectic that they didn’t avoid the downturn. When markets are sideways, they’re just plain frustrated. When they try to anticipate these movements they usually fail and when they don’t – a very rare event indeed – their next moves inevitably don’t keep up the good work. They hate seeming to start from scratch every day and living from transaction to transaction, dependent upon the machinations of markets for survival.

This profound disillusionment is well-earned, of course, and is predicated upon three primary problem areas: execution; expectation; and erroneous priorities. The basis for each of these problems can be established in surprisingly short order.

In terms of execution, the trade ideas they offer rarely turn out well and the performance provided by money managers, when they go that route, almost never meet expectations such that it’s not unfair to say that much of the money management business has been an abject failure pretty much across-the-board, even for the mega-rich. Poor investor behavior makes that dreadful performance even worse — we trade too often, at the wrong times and into the wrong instruments. We chase returns via managers, sectors and trades that have been hot only to be disappointed when mean reversion inevitably sets in. Our inflated expectations make matters worse still because investors expect outperformance as a matter of course and investment managers tell them to expect it, implicitly and explicitly. That’s what makes the sale after all.

Erroneous priorities include a failure to manage to personal needs, goals and risk tolerances as well as “plans” that change with every market movement. It shouldn’t surprise anyone that clients with huge appetites and tolerance for risk when markets are rallying frequently want to go to cash at the first sign of trouble. At the advisor level, the priority problem is even more fundamental and encompasses each of these problem areas. Much of what tries to pass as “financial advice” is actually glorified (or even not-so-glorified) stock-picking. In my experience, most advisors and their clients wrongly think that the advisor’s primary function is to pick good investment vehicles.

Advisors are well aware of the failures of the money management business, of course, as well as the limitations of a transactional business model. That’s a big reason why their disillusionment is so existential. They have been let down again and again by the idea that they have (finally!) come up with a formula for success only for reality to crush those promises. Even worse, and consistent with that conundrum, a 2012 study from the National Bureau of Economic Research concluded that financial advisors reinforce behavioral biases and misconceptions – the problems outlined above – in ways that serve the advisors’ interests rather than those of their clients.

Still, many of these advisors keep hoping against hope. They routinely tell me that if they proposed a data-driven, evidence-based approach with their clients that actually had a reasonable chance for success, their clients wouldn’t perceive a need their services. Not so coincidentally, that’s a big reason why so many advisors are terrified by the proposed Department of Labor fiduciary rule with respect to retirement accounts. And that’s why the Dilbert cartoon reproduced below about index funds (one possible data-driven approach but hardly the only one) is so wickedly funny.

Hierarchy 1

Proper advisor priorities begin with a recognition of what is important and what is achievable. That’s why I have created this hierarchy of advisor value, which was developed for a presentation I have been giving to groups of advisors. Hierarchy of Advisor Value (wide)(ATM)

Managing to this hierarchy won’t make the markets any less infuriating, but doing so will make the financial advice business much more fulfilling and gratifying. It can even make that business more lucrative, at least over the longer-term. Simply put, it will require carefully and truly putting the client’s interests first, even when the client doesn’t see it that way.  Continue reading

“That’s What They Offered”

trump-and-sandersBernie Sanders and Donald Trump are strange bedfellows to be sure. But they were the big winners last night when the first primary votes of the 2016 presidential campaign are cast and counted in New Hampshire as each won astonishing and overwhelming victories in their respective party contests. Let’s be clear. They didn’t just win. They each won by huge margins. And their successes have badly embarrassed party leaders and pundits.

These very different candidates have some surprising commonality. They have each found a rich vein of popular (and populist) support as insurgents attacking the insidious corruption wrought by big money in politics. They see the political fight they are waging not as an ideological struggle so much as a class war. They want to gain control of the presidential process and the political parties at its heart by hostile takeover. As they see it, since the system is rigged, only someone not beholden to big-money special interests can make things right. Continue reading

The Great Myths of Investing

GreatMythsAs the great Mark Twain (may have) said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” That’s particularly true in the investment world because we know, to a mathematical certainty, that avoiding errors provides more bang for the buck than making correct calls and generating outperformance. Fixing what we “know for sure that just ain’t so” provides a remarkable opportunity for investment success.

On the other hand, it simply doesn’t make a lot of sense to spend enormous amounts of time and energy looking for a strategy or a manager that might (but probably won’t) outperform by just a little bit. As the great Spanish artist Pablo Picasso put it, “Every act of creation is first of all an act of destruction.” What we want to do is to find the next great investor, the terrific new strategy, the market sectors that are about to heat up or the next Apple. But what we should do is eliminate the things that make it so hard for us to get ahead. Accordingly, I will highlight some of the great myths of investing — ideas that lots of people, alleged experts even, claim to be true and act as as though are true “that just ain’t so.”

There are lots of myths at work in our lives, of course, falsehoods that are often believed and which are used to further a favored narrative. But George Washington didn’t really cut down a cherry tree and wax eloquent about not telling a lie as a consequence. Isaac Newton didn’t come up with his theory of gravity because an apple fell on his head. Columbus didn’t discover that the earth was round (that had been established centuries before). Ben Franklin didn’t fly a kite in a storm and discover electricity. And Einstein never flunked math. If any of these are news to you, I’m sorry to have had to break it to you.

Such myths persist because they “work” in some way. Their story elements — ease of recall, readily adaptability, explanatory power — make them useful and even important.  But utility and truth are hardly the same things and neither are utility and helpfulness.

So here is my list of the top ten great myths of investing. Since they aren’t true and are indeed damaging, if you can eliminate them from your mind and your investment process, your results will necessarily improve. Continue reading

The Maleficent 7

Maleficent 7The Magnificent Seven is a terrific 1960 movie “western” about seven gunfighters hired to protect a small Mexican village from marauding bandits. A re-make is currently in the works and the “original is itself a re-make of Akira Kurosawa’s Japanese classic, Seven Samurai. Meanwhile, Maleficent is the “Mistress of All Evil” in Sleeping Beauty who curses the infant princess to prick her finger on the spindle of a spinning wheel and die before the sun sets on her sixteenth birthday. Today I’m offering up a mash-up from these movies to outline what I’m calling the Maleficent 7 – seven inherent human problems and limitations that impede our ability to make good decisions generally and especially about money. Continue reading

Beating the Bias Trap (Additional Resources)

BeatingBiasTrapLogoWhen I attend presentations of various sorts, I am often frustrated in that I want to try to take in and engage with what is being presented but I also want to take careful notes, especially with respect to direct sources. I also want to be able to check these and other related sources out for myself, both to “check the work” and to gain further understanding. Since I am presenting “Beating the Bias Trap” at FPA – NorCal in San Francisco on Tuesday, what follows is my list of direct sources and other materials relating to my subject. My goal is to help attendees get the most out of my presentation as possible. The list and its topics generally follow the order of my presentation. I trust that attendees will find it useful and that others interested in the subject will find some helpful materials. Continue reading

Everybody Plays the Fool (Sometimes)

Back when I was in high school, an R&B group called The Main Ingredient, fronted by Cuba Gooding, Sr., scored a big hit with Everybody Plays the Fool.

Everybody plays the fool (sometimes)
There’s no exception to the rule (listen, baby)
It may be factual, it may be cruel (I ain’t lyin’)
Everybody plays the fool

So, so true.

top10Everybody does play the fool at least sometimes, about love and money. So, in honor of April Fools’ Day, here is a helpful list of ways nearly all of us play the fool about money (sometimes). Remember, there’s no exception to the rule (listen, baby). Continue reading