The body of knowledge now called behavioral finance has been developing in earnest since around 1980. The more we learn about the way we interact with money, the more we see that our instincts are often not as useful today as when humans were developing many years ago. Our natural misconceptions are somewhat predictable and fall into identifiable categories. One of the most common biases is overconfidence, which manifests in many ways when it comes to investing.
For example, we will feel most comfortable investing in things we know well, even if it means we’re undiversified. One great example is the tendency to maintain large positions in your employer’s company stock. Geographic home bias is a problem, too, in that we’re more confident in investments in places we know. U.S. home bias has outperformed for the last few years, but then again Japanese investors did great investing locally up until the 1989 crash, too. Thirty-plus years later, the price return of the Nikkei 225 average is still underwater! When AT&T broke up into seven regional companies, investors were found not to invest in the Baby Bell with the best investment prospects but rather almost always in the one they knew locally.
To be provocative, perhaps the most costly form of overconfidence is when investors think they can select individual stocks and outperform the market consistently year after year. Most busy people have a hard time picking up their dry cleaning, so the idea that a working professional with family obligations can have the time to be effective at selecting individual stocks and bonds over the long run is a stretch, at best. What’s worse is that sometimes investors think they are winning, but it’s only because they remember the winners and forget about the losers.
I remember a TV show that did a tour of famous poker player Daniel Negreanu’s house outside Las Vegas. There was a large pool table in the basement, and the host asked him if he’s any good at pool. I remember he looked at her for a long moment and simply replied, “Well, I’m better than you are.” In the same way, with over a decade of daily experience in financial markets, several rigorous financial certifications, and a respected MBA, I suspect I’d be better at picking stocks than an average reader of this article. With that said, you might be surprised to learn that I think you would be foolish to ask me (or any other investment professional) to build a portfolio for you by picking a handful of individual stocks and bonds!
What value can an investment advisor add then? I don’t think an advisor can pick stocks to beat the market, but I do believe there are ways to beat the market in the long run without outguessing the market by picking the right kinds of funds. Aside from curating the investment portfolios, much of the value an advisor can add is behavioral. Talking clients off the ledge when they want to go to all cash almost always has been the right choice historically. Most people like to spend money on things and experiences, and a good advisor can get the signal from the noise and help determine if the time is right for a big purchase. Probably most importantly, advisors can figure out if those approaching retirement are likely to be okay or need to revise their plans.
If we were all like Star Trek’s Mr. Spock, then financial planning would be easy. We’re all fully human though, so you and advisors like me will have to continue to overcome our natural biases and emotions to make the best decisions amid uncertainty on our long-term financial paths.
Gene Gard is Chief Investment Officer at Telarray, a Memphis-based wealth management firm that helps families navigate investment, tax, estate, and retirement decisions. Ask him your questions or schedule an objective, no-pressure portfolio review at letstalk@telarrayadvisors.com. Sign up for the next free online seminar on the Events tab at telarrayadvisors.com.
