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Exploring a Destructive Investing Myth

This blog is an edited transcript from our podcast UnCommon Cents Season 1 Episode 3. January 13, 2021
If you prefer to listen you may do so by clicking here.

Hello, I am Jennifer Foster, your host, and I'm so thrilled to be back here with you today. In our last episode, I introduce you to my special guest who is back with me today. Keith, welcome back to the podcast.

Keith: I'm glad to be here.

Jen: Last time we talked about New Year's resolutions, goals, and our UnCommon solutions to fuel our dreams. It was a fun topic, but today we are going to talk about something serious. We are going to begin exploring the myths of investing.

Keith: Yes, and sometimes at SmartPlan Investing, we refer to these myths as traps or pitfalls, depending on what message we're trying to convey or our mood of the day.

Jen: They are synonymous: myths, traps, or pitfalls. They're all things that we want to steer clear of. We won't have time to cover all of the different myths today, but we're going to take a close look at myth number one, which is Stock Picking. Even though this is a serious conversation I came across this ridiculous article. I know we're past Christmas, but I thought since it wasn't that far away and it's kind of fun. And this article is in line with our topic today about Stock Picking. This article comes from Dartmouth College. If you want to look it up on their site, the funny thing is, it's under their Press Releases, and the articles titled.

Santa's Reindeer Are Better at Stock Picking Than U.S. Senators in 2020.

Santa's reindeer at Santa's Village in Jefferson, N.H., are more skilled at selecting stocks than U.S. Senators and members of Congress were in 2020, according to a Dartmouth study.

In analyzing the performance of stocks bought and sold by legislators, the researchers found little evidence that confidential information had been leveraged in terms of market timing and stock selection.

Jen: The reason they are researching this is that we really don't want those legislators that have privy information that isn't available to the public to be able to trade on the information. So, by doing this research, they analyze whether it looks like they've done that. There is a really important aspect of why they did this research, but I just think it's hilarious that Santa's reindeer apparently do not live in the North Pole, but are, in fact, in New Hampshire.

Keith: I was reading that same article. You emailed it over to me, and what they did was they went to a place called Santa's Village and they had the reindeer step on like newspaper sheets of stocks from The Wall Street Journal. They looked at the tip of the hoof and wherever the tip of the hoof landed, that was the stock that the reindeer quote-unquote chose. The actual journal article itself is very humorous because several undergraduate students that participated in writing this paper with their professor, acted as if the reindeer had methodically chosen out their choices. They're like, Oh, there's obviously some sort of, love of tech stocks or whatever the sector or industry was. So, I thought that was very funny.

Jen: It was hilarious, and it goes on to say: "Some people may think that U. S. Senators and House members have pretty limited stock-picking paralysis. But Santa's reindeer seemed to have a real knack for it. The strong performance of the reindeer portfolio could be due to luck, insight, or just the magic of the season." I will chalk it up to luck.

Keith: I don't know, maybe reindeer have incredible insight. You don't know them?

Jen: Yeah, but anyway, even though this is a serious topic, I just thought that was a good way to segue from the Christmas holiday into this topic.

A Random Walk Down Wall Street

Keith: And speaking of animals and investing if I can keep us from going too serious of a direction. There was written in Burton Malkiel's book A Random Walk Down Wall Street, where he talks about how monkeys throwing darts at the Wall Street Journal's selection of stocks would create a portfolio that would be just as good as getting incredible insightful investors to pick a portfolio. There have been some people that have tried to mimic this. John Stossel has done it on TV, I think more than once, to hilarious results. I was watching a video earlier where he was on a panel at Fox Business where there were financial analysts that pick stocks for a living. Those analysts were like "you're trying to put me out of a job." And he's like, "Well, you know, I'm just looking at the evidence." But I also was able to find an article from, 2013, written by Arnett. An article called "The surprising Alpha from Malkiel's Monkey and Upside-Down Strategies" where they basically backdated 50 years. It's the same idea. Obviously, it's pretty expensive to get actual monkeys to throw darts for a variety of reasons. For one, I wonder how much it costs to rent a monkey for an hour. Yeah, much less, a monkey that knows how to throw a dart right at the intended target as opposed to the people in the room with it. This could all go wrong very quickly. So, they took a less expensive and much safer approach. And they just kind of backdated a randomized selection of 30 stocks or 30 stock portfolios and this is 100 different times, and they were able to outperform the market like 96 out of 100 times. So, this all goes to say that Burton Malkiel was wrong, about monkeys throwing darts, which is just a proxy for randomness. Monkeys throwing darts doesn't do just as well as Wall Street investors, they do much better, right?  

Recognizing Forecasts and Predictions

Jen: And what I love about this topic here that really ties into some emails that I get on a constant basis. Based on the academic research we believe that markets are random and unpredictable. We also believe that Stock Picking is relying on a forecast or prediction. I think what's important for investors to get out of this conversation is the ability to start recognizing either in ads or in conversations or wherever they're getting information from when they are being, you know, subject to these forecasts and predictions. So, out of this recent email that I received here's just a few headlines. If you have a pen jot down a tally every time you read some sort of forecast or prediction.

Digital Assets Set To Soar In '21
S&P 500 Will Tumble 20% Before Rallying To 4,500
Strategist Predicts Trends For 2021
Market Is In An 'Epic Bubble
Covid's Worst Should Be Over By Valentine's Day
What Lifted Trump Could Sink Biden

You should have counted six. What you can see here Keith is each one of these headlines is filled with some sort of prediction about the future, right?

Keith: Yes., it just permeates the industry, and this is just a small sample of headlines that we get emailed regularly. Obviously, this is a small sample of the stuff we receive week in and week out. It's all more predictions, more forecast, and more speculations. Sometimes they win, sometimes they lose. Sometimes they're right, sometimes they're wrong. That's kind of it. It's sometimes a chance. It's just rhetoric that sometimes gets substantiated because of luck. If someone says "that the market will tumble 20%" or some other prediction and it happens then that person comes back and says, ``Look, I predicted it and I was right. However, what about all of their other predictions that were not right? They just hope everyone forgets them. And I've heard this on other podcasts they'll have economists as a guest and the host is thanking this guest for coming because they accurately predicted the housing bubble crash or something. Yet they don't talk about this guy's wrong prediction on say, gold or whatever.

Jen: Exactly. They'll just so conveniently leave out the ones that they didn't come true. Stock Picking for those of you who don't really know what it is, it's just what it sounds like. It's choosing individual stocks and it can be done on a larger level even through mutual fund managers. The managers who run a mutual fund have to have at least 20 stocks. There may be 50 stocks, or 100, or however many stocks they want, but they're still picking and choosing which stocks are going into that portfolio. And they're doing it based on the fact that they believe that those stocks will do better than all the other stocks or better than the market asset category that they're in. For example, let's say the stock falls in the S&P. So maybe that is their benchmark, the fund manager wants to do better than the S&P. Theoretically, they want to pick the best stocks from the 500 they can choose from, so that would be considered Stock Picking. Otherwise, they may just buy an index of the S&P 500. Because it's based on somebody's forecast or prediction about the future, we call this Investor Prediction Syndrome. It does sound like a disease.

Keith: It might as well be.

Understanding Investor Prediction Syndrome

Jen: What we see with Investor Prediction Syndrome is that investors think that when they're choosing these stocks that they're doing this based on logic. Investors tell me all the time the reasons they picked these stocks. They are usually very proud of themselves thinking that they're being so logical about it. But you know what? It's really not their logic that's driving it. What we find from experience and research on investor behavior is that over and over it's our biases and our emotions making these decisions. In a future episode, we will take a deeper dive into biases. However, there are a few biases that we see often and the first one is Recency Bias. Keith, would you like to tell us what that is?

Understanding our Biases

Keith: Recency Bias is looking at and choosing stocks that have done well recently. It's the idea that I'm going to invest in Tesla why? Because Tesla did well recently, maybe in the last year. People seem to remember the past, but they specifically seem to remember the recent past.

Jen: Then there's another one called Confirmation Bias that is also very common. Keith, why don't you tell us about that one?

Keith: Confirmation Bias is just that when investors make an investment, they may begin reading a bunch of articles, but they basically are reading or remembering the articles that tell them how great of an investment decision is that they just made. So if you're investing in Tech Stocks, you're going to probably read a bunch of articles about how Tech Stocks are what you want to be in right now. People like feeling good about decisions they already have made, or even the ones that they're thinking of making. There is this faux logic that they're pretending to have good reasons for some of the mistakes they're making in life. They're just looking for evidence to back up the decisions that they make. They just need something to confirm.

Jen: Then because we all live in the world, and we then want to be alike, there's this thing called Herding Bias. Keith, do you want to tell us about Herding Bias?

Keith: It's looking at what others are doing. Asking yourself what are my friends doing? If enough people are doing this, then I'm going to do it too. Maybe you see a lot of people buying Apple Stock or whatever. So, you want to also own Apple Stock? It's FOMO=Fear Of Missing Out You don't want to be left out, and so you're doing what everybody else is doing. Regardless of whether it makes you money, whether it's a sensible investment, whether or not it makes any sense to Stock Pick, to begin with. A lot of times people don't even really look at what they're buying and why they're buying it.

Jen: What's everyone else doing? It's a story as old as time, right? Also, there's also this thing called Familiarity Bias. Keith, Do you want to expound on this one?

Keith: Familiarity Bias is kind of similar to Herding Bias, but more focused on what the investor is familiar with. I referenced Apple stock earlier. I feel like everybody and their mother who Stock Picks owns Apple stock. Many investors like it because many people have iPhones and are familiar with Apple. That doesn't mean the company is going to grow in the future: in fact, that probably means that they have a market share to lose. However, investors like what they know. People are familiar with what they know. To a lot of people out there, to be honest, what they know, as far as they're concerned, is all that there is. Everything else sounds foreign to them. They don't want to deal with things that are unknown to them. It's better the devil you know than the devil.

Jen: There are many ways to Stock Pick as we explored today, but what's really wrong with this? In our opinion, we would say this is destructive behavior. We'll talk about it in a minute, but Keith I'd like you to talk to us about the absurdity of Stock Picking.

The Absurdity of Stock Picking

Keith: It comes down to just the information you know, versus the information you don't. Also in this is unknowable information. So, let's look at Tesla. If I wanted to buy Tesla, I could go to Yahoo Finance, and I could look at their financials. I can pull up their balance sheet, income statement, cash flow statement, and I could look at recent news articles. I can do some research into the company to gain some knowledge or unknowable information and move it into my knowable information. I could look at news articles on their CEO. Elon Musk.

Jen: Yeah, he broke news today as the richest man on the planet.

Keith: What time did you see that? Because I saw an article today that he was the second richest behind Jeff Bezos by about three billion.

Jen: Well, it must have just changed, that was about 30 minutes ago also.

Keith: Okay, then. That's probably correct, because, really, that all has to do with what the Stock price is of Tesla at any given moment. And that's essentially Elon's network. He also created SpaceX. So, I know he must be smart, right? He must know what he's doing. And boom, that's what I know about the company. I have a good friend who works at Tesla's, so I could ask him probably some stuff, but I wouldn't be able to trade on that unless it was already public information anyway. Right? Because we don't want to do insider trading because that's illegal. I could go to Google and find information, but so can every single other investor on the face of the planet, right? Not to leave out all the professional managers who have access to this information. These managers literally get paid six and sometimes seven figures to research this stuff. They make portfolios for living working 40 plus hours a week on Wall Street in New York City. Probably right now from their homes that are very expensive on Staten Island or whatever. But they have that same information you do, and they have insanely more time to use it and to compute it. But what we don't know is what's inside Elon's head, right? You don't necessarily know some of the things that are discussed kind of off the record by some of the top-level people in that company, right? You don't know what other car manufacturers which are going to copycat off of Tesla and possibly sell cars at a much lower price point. You don't know what their competitors they're going to do exactly. You also don't know what public scandal Tesla could run into in the next year. There could be a change in energy policy by the stroke of a pen. There could be another pandemic and maybe they completely stop production. Who knows what could happen? There's also different political regulatory situations, global phenomena that could happen. The unknowable information nobody has access to Just look at 2020. Perfect example. There's a lot of industries that failed that people weren't necessarily expecting them to fail.

What you don't know, can hurt you

Jen: We don't know the plans of all of the people that own Tesla's stock or any stock. Like, are they gonna be retiring and cashing in the stock? When you cash in the Stock if a lot of people are doing it at the same time, like during a pandemic because that can drive the price down. We don't always know other people's emotions and instincts. When there's new information it may be scary. There's just a lot of things that we don't know that can affect the price of the stock. The price of a stock is based on everything we currently know about the stock. As well as, what we know about its past and everything we think we know about the future. What changes the price is unknown and unknowable information, right? And so who knows the unknowable new information? No one until it gets reported by the news outlets, and then everybody has access to it. I know some people that bought stocks and they've done really well. But I also know people who've gone to casinos and done well there. Right? The point I want to make is it is a gamble because you might get lucky Stock Picking, or you might not. Being that investors are putting their life longs worth of savings into investments; Stock Picking is destructive behavior. Maybe you are thinking, what are you talking about? I've led seminars, and I've had people challenging me on this. And Keith I know you've been there before, so you've seen it. But I'm not saying that every time someone picks a Stock that they don't make money. And I'm not saying that they can't make money over long periods of time.

Keith: Yeah, you're not saying people never make money.

Jen: Right, I'm saying that the behavior can be very destructive, so just know the difference between behavior and results.

Keith: In fact, one of the worst things can be when an investor has some success. We were talking about biases. They're attributing their luck to skill. Then they keep going, remembering the glory days of when they got a few good trades, and they keep persevering through all the times when they're losing money.

Jen: I just talked with somebody recently when they're just telling me that what they're doing is so great. And I said okay, so what was your biggest loss? They said $20,000. And then I said, okay, so how much did you pay in capital gains last year? Nothing. Oh… so you haven't made any money at all, right? And how many years is it going to take you to carry forward that $20,000 loss as write off? Oh yeah, that's assuming you're not adding to this number. Investors tend to remember the good stock that went up, but conveniently forget the bad picks.

Keith: Yeah, it's common. I encounter this at gatherings, maybe a Christmas party where I meet people with a beer in one hand and a cigar in the other bragging about their great Stocks picks. They chose this last year or whatever. What they're not wanting to brag about are all the stocks they picked that weren't successful. They only mentioned the success stories, which is another bias by the way called Success Bias.

Jen: There you go, and we will get into another episode where we will dive into the biases. But again, I just want to be clear that we talk about Stock Picking as being a destructive behavior. I'm not saying that all the time people don't make money, or they don't have positive results. And I will say positive results are debatable. That's a whole different topic because we can and do an analysis for investors. The analysis compares the investments asset category that they're into a well-diversified portfolio over the last 30 years. Maybe the investor has done very well, but for the risk that they're taking, oftentimes they're giving up, like 50% worth of returns over 30 years. I mean, it's massive. So, we believe that's destructive. If you could have had twice as much, that's twice as much impact they could have on the world. How many children or grandchildren could they not send to college, or ministries they weren't able to support, or whatever that they weren't able to fulfill because they didn't have the money they should have possibly had if they were diversified.

Keith: You're hitting on a few things, but one of the issues that also need to be pointed out is there are some people who kind of dabble in it. They show me cause I'm in the industry. So, they're like, Oh, I want to show you what I invested in okay. I ask what their returns were and sometimes they're excited when they have positive returns. But oftentimes some of the people I've talked with don't even beat the market. It's like you could have just saved all of the time and effort, and you could have made more money by just investing in the market versus Stock Picking.

Understanding the difference between destructive behavior and results.

Jen: Exactly. And you brought up Tesla and Tesla was reported as the number one stock out of the S&P 500 in 2020 But did you know there are other stocks that are not in the S&P 500 other asset categories where there were stocks that did exponentially better than even Tesla's? If you really were that great of a Stock Picker, you would have picked those stocks, right? Again, just going back to destructive behavior. I like to use some sort of analogy or story to really help. I think stories and analogies help us to remember these things and stick with us. Imagine that every day after work, you decide to go to the local pub or bar or whatever. I'm not in England, but I like the word pub better than bar. So you go to the pub every day and have one too many drinks and you drive home and every time. And say that every day that you do that, you get home safely. Is it destructive behavior to drive home every day after work, having one too many drinks? Absolutely. Now imagine that one of the days that you're driving home, you swerve into a lane and you hit a van and inside is a family, a mother, a father, and their three small children. Sadly, everyone inside the van dies. Was that destructive? I don't think anybody would say "no." Yes, it's destructive, but the behavior has always been destructive. It's just that once you hit that van and everyone inside dies that you feel the impact of the behavior. And that is a lot of what Stock Picking is like. The behavior can be very destructive, but you might not feel the impact right away. So I think if you just can keep that in mind. Here are a couple of problems and reasons that I'm against Stock Picking. First, because all the money that you've saved for your whole life is that stake. Just one mistake can wipe out a whole lifetime of your savings. Your dreams are a steak because that money that you had was for your dreams. Whether those are dreams you're fulfilling right now, or dreams you're going to fulfill in the future. But those are dreams that are at stake. For many investors that I know, they want to leave a legacy or leave generational wealth, and that's at stake. And the very saddest part is that someone's very life could be at stake. Because people have committed suicide over money, and over-investment decisions that they've made. So investors get to choose between different worlds of investing. They can choose the world of Investor Prediction Syndrome that is relying on a forecast and prediction about the future. When they think a stock will go up or down. What area of the market is going to go up, and when it's going to go up. It really is relying on forecasts and predictions of the future.

But there is another world of investing that eliminates this forecasting and predicting, and it's called Academic Investing Principles. For an investor to choose which world they want, to align their money and investing. They need to be able to explore these at a deeper level.

We have a virtual event called the American Dream Experience. The American Dream Experiences a profound, powerful, and entertaining exploration into something that is often left undiscussed. That's your family's financial future. And at the American Dream Experience, you may alter your relationship to money and invest in a way that leaves you and those you care about powerfully pursuing your dreams.

Does Stock Picking Work?,active%20managers%20in%20many%20years.

Santa's Reindeer Are Better at Stock Picking Than U.S. Senators in 2020.

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I want to thank you for tuning into UnCommon Cent$ today and learning about the first myth, Stock Picking.

To learn more stay tuned for our next episode as we'll explore this topic even further. We look forward to seeing you here at UnCommon Cent$. Until next time, stay savvy and be blessed.

This is not an offer or sale of securities. All investing involves risk, and particular investment outcomes are not guaranteed. This podcast is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation for any security, or an offer to provide advisory or other services by Jennifer Foster or SmartPlan Investing in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information should not be construed as financial or investment advice on any subject matter.

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