You’re right that education isn’t a silver bullet for overcoming behavioral biases.
Many biases are deeply ingrained and can affect even knowledgeable investors.
However, I’d argue that education and understanding still have significant value:
Knowing market history can help put crashes in perspective
Learning about long-term investing can help us treat daily/monthly/yearly flactuations as noise
It can reinforce your confidence with hard data about the success of the plan
Even being aware of our biases could help us fighting them
Completely agree, but as I said, education alone does not help. You have to have a plan of what to do. Mine is very exact and leads to the correct actions that I did identify long before.
And almost every time it was a very profitable action I almost missed it because my complete body and brain went against it. I did hate what I had to do, and almost nobody does what he hates to do. Bias in action, even if I know them all and all the details. Lucky I did stick to the plan, mechanical investment.
It’s a bit like eating well, getting enough sleep, going to the gym, flossing your teeth. Everybody knows what they should do, but maybe lack the will-power. On top of that stocks make it very difficult as you often need to overcome centuries of evolved flight instincts.
I think one way is practice and habit (hard to do as you don’t have a crash every year to drill on). A more secure way would be to really take it out of your hands e.g. put funds into the trust and give the trustee the rules that they have to follow. That way you cannot deviate from the plan.
Otherwise, even with a mechanical plan, you have to contend with actually sticking to that plan versus panicking in case of some event and deviating from your set plan.
To be honest, I think lot of strategies can work if one has time, patience and interest
For example when I started investing I tried to pick stocks individually. Almost all companies I invested in have gained in value over the last four years. Except BLOCK (ticker SQ)
But I realised I didn’t have patience to keep doing that as I always felt prices have increased a lot and I need to reinvest. So I decided it’s okay to chill (with index funds) because whatever I do, my returns over long term will end up being the average anyways. Anything else will be luck which I might call strategy.
Just to repeat my point: index investing does not get you the average. Depends a bit on the index, but you will buy a lot of companies that I would not even touch with gloves. Most indices are kind of momentum strategies, but not exactly the way I like it.
The most followed index, the SP500, did change or break its own rules twice in the last decades, both times at the high of a bubble. The committee is as biased as everybody. Just avoiding that stupidity would have made you a lot of money, especially if you take compounding into consideration.
I do construct my own index, actually two of them. And I have rules that help me in my personal situation. But they are mechanical, exact instructions how to behave, how much of what to buy or sell when. That is the most important part.
Depends on the math, there are a lot of ways to construct an average. Some index do not include all stocks, some do strange math and the rest is market cap weighting which always leads to probably not so optimal momentum investing. It means that you buy a lot more of the stocks that have already had high market appreciation and a lot less of others (that may have the same in the future).
Anyhow, if an index changes its rules there is no way one can speak of an average. It is just as biased as every single investor…
On average you cannot beat the average, at least not everybody, pure logic. But what average?
My point is that you can calculate averages in many different ways. How are single companies weighted, just by market cap or by enterprise value or just one by one? By sales, earnings, weight of the CEO? Or more by how the members of the committee that choose the index participants did sleep last night…
I even think sometimes that comparing my performance to indices is wrong, even it is nice to see that I make more money. Because indices are not the average.
Here are some mechanical indices which probably would be better for comparison for my dividend portfolio. Or, if I want “the average”, just buy one of the ETF for those indices.
I would say it is the average performance or the average risk or a combination of both every and all investors have. But there are already three possibilities, performance, risk or combination of performance and risk.
An index is no good measurement. Because index investing does not shield you from behavioral risk. As already mentioned there is the risk of your own trading and the risk of the index board being biased.
Your own trading risk can be minimized by a mechanical strategy (! yes, almost like I do myself), the other risks are always present. You buy the most expensive stocks that had a good run in big quantity and the cheap ones that may have a good run in the future in very low quantity. A typical behavioral failure.
I used factors long before they were called factors and became famous, actually long before ETF became famous.
I use value, carry and momentum. But of course I have very original rules to filter out my pickings.
Historically tested momentum was best in average. I think I did read an UBS paper with hundred years or so of testing. Other factors had times they were better, but momentum on average was almost always better than the “market” (in form of an index).
I use momentum in both of my mechanical systems, but not in a way one would think. The dividend strategy uses all three factors, value, carry and momentum, but momentum is only used to decide not to sell a stock when it becomes overvalued. That has proven to be very profitable.
As an example I would have had to sell Broadcom a long time ago when it became “overvalued” in my cash flow measurements. The gain in Broadcom is that high thanks to the cyclic nature of the stock and my market dividend concept yahoo refuses to even show how much I made, I suppose because of the split. Last market dividend was at almost the entry price… before the split. Calculating by hand I am at +582% there.
Please don’t be blended by my multibaggers. I have a lot of them and of course I like to write about that. But then I probably have even more losers that I get rid of soon and I may write about the transaction and then just forget about them. The cost of doing business.
As almost everywhere in investing a compromise is best. So yes, two opposite actions like rebalancing and momentum can and I think do give me an advantage.
I think I did already explain what I do exactly. Rebalance works with market dividends (6% sell down to 5%) and dividend reinvestment (only in stocks I would still buy and are less than 4%), percentage always in portfolio value.
Momentum works as a negative on selling, overruling the value parameters. A stock that gets expensive can get much more expensive.
And here is one of my compromises: partially sold today from my double position of Kyndryl after a year since buying the second position. Actually at a gain of 87.5% of the average entry price.
Contrary to what you may think I am in no way against index investing with ETF. I even counselled some friends to do exactly that. But with some precaution.
There are more index today than stocks traded. Choosing what is right for you therefor may even be more difficult than picking stocks. It pays out to invest a lot of time and effort there and then stick to it.
There are risks you can limit. The most important risk for me is the behavioral risk. I feel it every time: when an action I have to take because my mechanics tell me so hurts most… it is probably the most profitable action. I would never buy or sell at that moment if my strategy would leave me options.
Check the index you want to invest in for its stock picking mechanics. If it is not completely mechanic you have a behavioral risk. If it is mechanic but did change or break its rules in the past you have a behavioral risk. Those risks are expensive as the SP500 index shows, I think it changed/broke its own rules twice at the high of a bubble.
Everybody makes mistakes. Index investing could help you to avoid those expensive errors.
Do you mean that Yahoo was added in 1999 and Tesla in 2020? You’ve written about this about ten times on this forum already, and I still don’t understand how these two impacted the long-term returns of the S&P 500. The problem with both was that they were added at a time of high stock prices, with sharp drops shortly afterwards, but I don’t think that mattered much if you held the ETF, did it?
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