We’ve written many times about the biases we all face as investors. Recency bias and confirmation bias are two big ones investors should try to overcome. The first chapter in Morgan Housel’s book, The Psychology of Money, is titled “No One’s Crazy”. He writes, “Your personal experiences with money make up maybe .000000001% of what’s happened in the world, but maybe 80% of how you think the world works.” This, of course, addresses a powerful question: When it comes to investing, how much influence do our past experiences have on our current attitudes/strategies?
Last week we had two client conversations that are good examples of this type of bias. Both are very successful in their careers, earn a high income and have amassed a good amount of wealth. However, in separate, private conversations with each of them, Client A expressed an interest in adding more Artificial Intelligence (AI) exposure to her portfolio. AI is a tremendous technology, but many believe that valuations in this area are already reflecting this optimism. In other words, this area of the market may be considered too expensive by historical standards. Nonetheless, Client A stated, “AI is the future so maybe we add more exposure to it...and have less portfolio diversification?” Just a short time later that same day in a review with Client B, we listened to his view that the overall market (especially the tech/AI sector) is irrational and might see a significant decline; he wanted to explore strategies to protect his portfolio from a large drawdown.
Two entirely different views. Who is right? Who is wrong?
As Housel says, “No One’s Crazy”. Why then could they have such different viewpoints? Perhaps because of their respective experiences. Client A is much younger than Client B; she was too young to experience the tech bubble and did not have much wealth at stake during the Great Financial Crisis (GFC). Client B, on the other hand, lived through both events and works in the financial industry. And as anyone who was heavily invested during the GFC, he remembers all too well that period when the S&P declined nearly 60% and not only that, there was risk he would lose his job as well. Further, Client B is close to retirement and clearly does not want to experience another financial crisis and wait for his portfolio to recover. Conversely, Client A has only had success with tech stocks in her investing experience; after all, this sector has been a spectacular outperformer for the last 10 years or so. Her portfolio has benefited and she has enjoyed strong gains during this period.
As we reflected on these conversations and how we may address them through portfolio moves, we asked ourselves: "Do we think Client A would feel the same way if she had significant wealth invested during the tech bubble?" And, similarly: "Would Client B feel the same way if he wasn’t working on Wall Street during the GFC?"
We think the answer is undoubtedly NO to both.
And therefore, the overriding message here is that we should all try to become better investors by challenging our own views. Are we allowing our experiences to heavily influence our investment strategies, thus taking on too much risk....or not enough? Are we succumbing to recency or confirmation biases? Any of these could possibly be obstacles to achieving financial independence. Instead, we should always try to keep things in perspective and make sure we are not straying from our financial plan.
Two other points Housel makes that we can relate to in our day to day work with clients: “There is no one right way to do things, only the most right way for you” and “Understanding what makes people tick is the first step toward a more rational financial future.”
Our role as advisors is to help these two clients (...and all clients) craft the appropriate personalized investment strategy that reflects their own unique goals, risk tolerance and objectives. We all make decisions based on our own unique experiences that seem to make sense to us in the moment. However, our role as professionals is to also challenge our clients’ thinking, not just make changes to their portfolios based on what they ask for or think....in the moment. The better we do at understanding what makes each client tick, the better chance we have to help them accomplish their financial goals and reach financial independence!
We hope everyone has a great weekend!
All the best,
NCM Capital Management
Disclosures: This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of NCM Capital Management, LLC and are subject to change at any time based on market and other conditions and NCM does not undertake to update or supplement its newsletter or any of the information contained therein. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable. There is no guarantee that the investment strategies discussed above will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV. Readers are encouraged to consult with their own professional advisers, including investment advisers and tax/legal advisors. NCM Capital Management, LLC does not provide legal or tax advice. NCM Capital Management, LLC can assist in determining a suitable investing approach for individuals, which may or may not resemble the strategies outlined herein.