Our Own Behavior Can Make Owning Stocks More Risky

Don’t Shoot Yourself in the Foot Investors can, by their own behavior, make stock ownership highly risky April 2, 2015 “The fault, dear Brutus, is not in our stars, but in ourselves.” Warren Buffett used the Brutus citation above in his 50th annual Berkshire Hathaway shareholder letter about how so many investors shoot themselves in the foot. In his letter, Buffett writes: If the investor fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement […]. If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well. Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a lifelong owner of equities would otherwise enjoy. Daniel Kahneman, the Nobel Prize winning psychologist, spoke on the lessons of behavioral finance at an conference for advisers in New York two days after this year's Super Bowl. He spoke of hindsight, in which “an event seems predictable after the fact.” His example came from Super Bowl XLIX. “Look at the amount of credit the Patriots got after that stupid play” in which the Seahawks attempted a last-minute goal-line pass that was intercepted. If the pass had worked, he said, the commentators would have been praising the Seahawks. “Hindsight induces us to believe we understand the world because we understand the past,” a particularly dangerous belief for advisors to exhibit, he said. Clients will “feel the pain acutely” of lost investment opportunities. He suggested that's why so many investors, having seen an investment rise in value, will seek to buy that investment after it's had its run. It's also why mutual fund investors rarely profit from the full increase in a fund's value, since they will far too often buy into and get out of funds, to their detriment. Finally, Kahneman spoke of the issue of overconfidence, telling his advisor audience not to “trust your own confidence” and to remember that “you cannot predict the future.” Instead, “be confident in the principles and processes you use to work with people, not in what stocks, bonds or the markets will do.”

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August 2, 2018 by Larry Swedroe of Bickingham Alliance(BAM) a nationa...

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