For some of us, it’s hard to give up on the idea that investing should be exciting. Picking stocks can be fun, after all, and there’s nothing like getting your timing right and bragging about it later with friends.
For all the accumulated wisdom about asset allocation, risk, diversification and discipline, some people seem bound to see investing as an end in itself rather than a means to an end. For these folks, picking stocks is a hobby. They follow the gurus and soak up the financial media. Despite evidence to the contrary, they’re convinced they can build a consistently winning strategy by exploiting perceived mistakes in market prices.
Part of the reason is the human tendency toward overconfidence. For instance, we all like to think of ourselves as above-average drivers, when that’s simply not possible. Likewise in investing, many of us believe we have powers of foresight not evident in the wider population.
A Duke University study of corporate executives published in 2010 found a dismal record of prediction among a group you might think would do well. Indeed, of 11,600 forecasts for the S&P 500 over nine years, the survey found executives’ estimates of future returns and actual outcomes were not even close. In other words they were hopeless forecasters and should keep their day jobs.
Research also suggests the tendency to trade a lot and make confident forecasts about stocks has a gender bias. Whether it’s a testosterone-driven instinct among men to boast or something else, study after study shows men find it harder to accept that they are unlikely to “beat” the market.
For these overconfident and overly aggressive folks, an investment approach that advocates working with the market, diversifying around risks related to an expected return, trading efficiently, exercising discipline and watching fees and taxes sounds like the financial equivalent of a broccoli and walnut salad: healthy but boring.
Surely the point of investing is to try hard and stay in the arena even when knocked down. The idea that such an approach is like Don Quixote charging at market windmills is not palatable. Such aggressive investors long for the vision of great success even if it is an illusion.
There are a couple of ways to confront and counteract this mindset. One is to hope for a change in human nature and persuade each would-be master of the universe to separate his urge for ego gratification from his need to build wealth patiently and efficiently. This is not impossible, but it is unlikely. One suspects it would take some time and would require creative ways to save face.
A second approach is to separate the investment nest egg from the play money. If someone really wants to speculate, let them do that with the proviso that important money, like long-term retirement money, be invested the boring way. This way, the investor can buy some expensive entertainment and accumulate a few colorful stories to share at his next golf game without compromising the asset allocation painstakingly designed for him and his family.
It’s understandable that investing is a kind of a hobby for some people. After all, this is what keeps much of the financial services industry and media in business. But by separating the concepts of speculation and investing, you can still enjoy the occasional treat while maintaining a balanced diet.
Call it the broccoli and pizza portfolio.
Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from UC Berkeley. Contact him at firstname.lastname@example.org.