An Integrated Advisor Network firm

When I start a sentence with “When I was…” my daughters smile because they know what is coming next. As a matter of fact, they usually complete my sentence for me by saying “… a beekeeper.” It appears that my habit of beginning stories of my beekeeping days with that phrase is very predictable.

When I was a beekeeper, I worked as the foreman for an outfit with 6,000 hives. Contrary to what you might think, we sold very little honey and made most of our money from selling bees. Back in the 1970s, we sold 60,000 queens and 40,000 pounds of bees per year. Our busy season was from January to the middle of May. During that period, I worked every day and regularly had over 100 hours on my weekly timecard. The remaining 68 hours, I ate and slept at the bee farm, so I was immersed in bees 24 hours a day, seven days a week. I thought about bees so much that after a while I started thinking like one.

Yes, bees do think. According to a 2012 blog by Jon Lieff, MD, “Most scientists have …assumed that advanced behavior in creatures with very small brains, such as the bee, must be ‘hard wired’ rather than responsive and changeable.” It was thought that bees did not have enough neural capacity to think, so they must be acting instinctually. However, researchers at Queen Mary University of London have discovered that thinking, remembering, and learning “…can be easily done with the smallest of nerve cell circuits connected in the right manner…” As Chrissy Sexton explains in When it comes to bee brains, size does not matter, how the brain is organized “…is much more important than the size of the brain.”

In Expert Political Judgment, Philip Tetlock explains the situation is similar for humans, which is a relief since my hat size of 7 1/8 is smaller than the average of 7 3/8. “How you think matters more than what you think,” is how he describes it. In other words, “It’s the process, stupid.” And, Robin Hogarth points out in his groundbreaking book, Educating Intuition, the reliability of your thinking process depends on the environment in which you are operating. Bees operate in what he calls a “kind” environment, in which lessons learned from experience can be trusted. The location of hives, the smell and shape of desirable flowers, and the differences between harmless and dangerous fungi are relatively constant. So, the reliability of lessons learned from experience can be trusted.

However, psychologist Thomas Gilovich, in How We Know What Isn’t So, says, “The world does not play fair. Instead of providing us with clear information that would enable us to know better, it presents us with messy data that are random, incomplete, unrepresentative, ambiguous, inconsistent, updatable, or secondhand.” Hogarth calls such environments “wicked” and Tetlock’s research has demonstrated that financial markets are some of the most wicked environments. However, Tetlock warns that we can’t just blame a wicked environment for poor financial decisions. “A warehouse of experimental evidence now attests to our cognitive shortcomings: our willingness to jump the inferential gun, to be too quick to draw strong conclusions from ambiguous evidence, and to be too slow to change our minds as disconfirming observations trickle in.” We do this, writes Hogarth in Psychology Today, because “…we have difficulty differentiating between kind and wicked learning environments… As a result, we may think we learned the right lesson, even when we didn’t.”

When I start a sentence with “When I was,” my daughters have learned from experience what comes next. Similarly, as a beekeeper I lived in a kind learning environment that was repetitive and predictable. So, when I was a beekeeper, I though like a bee and learned like a bee, but when I became an investment advisor, I had to put away such simplistic things. I had to, because in the wicked world of investing you can’t trust what you think you know. As Mark Twain reminds us, “What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so.”

On June 6th 1678, Zipporah Bolles was murdered by a deranged sixteen-year-old boy. The boy was upset because Zipporah had refused him lodging. In his confession he said that he snuck into the house with an axe and struck Zipporah on the head as she sat on a stool holding her baby. He then proceeded to kill her two older children, but for some reason, he stood over the baby boy laying on the floor next to his dead mother and decided not to kill him also.

The baby was John Bolles, and I bring it up because I am in his direct line of descent. Claire, my niece and our family’s resident historian, wrote that reading the account of this tragedy “…really drove home for me the fragility of life and how a turn of events, now or hundreds or thousands of years ago, can change who walks the earth today, and who never did. Amazing.”

Personal growth consultant, Dr. Ali Binazir, said it is so amazing that it is a miracle. He calculated the probability of you being born as “…the probability of 2.5 million people getting together… each to play a game of dice with a trillion-sided dice. They each roll the dice – and they all come up with the exact same number.” And since his definition of a miracle “…is an event so unlikely as to be almost impossible,” we are all miracles.

Compound growth has also been called a miracle because, given enough time, a small amount of money can grow into unbelievable wealth. Albert Einstein was purported to have said that compound interest was mankind’s greatest invention, describing it as “…the 8th Wonder of the World.” The chance that he actually said that is probably only slightly higher than the probability of my birth, but it makes a great story. However, there is no question that Benjamin Franklin said, “Money makes money. And the money that makes money, makes money,” which I think is a brilliantly simple and clear definition of compound growth. In other words, compound growth is the growth of both the earnings of an investment’s initial principal and its reinvested earnings.

Unfortunately, for most young people their initial principal is zero. So, savings is required to create principal for compounding. The numbers suggest that starting at age 25 a young person should save 20% of their income every year until retirement. But even if they do, the reality is that for the first 20 years the majority of growth comes from the new savings because there is not much principal to compound. It’s not until age 50 that even the best savers have accumulated a substantial enough principal base for compound growth to really have an effect. The result, according to retirement expert Michael Kitces, is that most people are far too reliant “…on the biggest part of the compounding curve to hit exactly when they need it -- if they don’t get that last doubling… in the final 9 years, their retirement plan can be dramatically off track. In response, that means clients… need to acknowledge how remarkably uncertain their actual retirement date will be when committing to a savings/accumulation plan…”

The fragility of financial markets is like the fragility of life in that a turn of events at an inopportune time can significantly undermine our financial plans. But, unlike the timing of our birth, the success of our financial plans is not totally out of our control. And that’s because, according to Gandalf in The Fellowship of the Rings, we all get to decide “…what to do with the time that is given us.” So, live modestly, save regularly, invest prudently, and if things don’t work out as planned – work a little longer. Remember, life doesn’t always follow our plans, but it’s always a miracle.

"What do you want for dinner?" my wife asked on our first night as newlyweds. Her question was about what I felt like having, but for me it was about what I should have. It was a response she did not expect, but then again, from the moment of our first date I was always doing things she didn't expect. On that first date, I had asked her out for a bicycle ride but showed up without a bike. I ran the 10-mile loop through the park while she rode her bike. Another thing that surprised her was that when I said "good night," I was asleep the instant my head hit the pillow. 

Healthy eating, exercise, and sleep are disciplines I have consistently maintained which have served me well, especially during times of stress such as we are experiencing now with the COVID pandemic. Health and wellness coach, Kari Pendray, defines stress as "...when the need to respond exceeds our capacity to respond." She explains that there are three forms of stress - acute, episodic, and chronic. Acute stress is caused by things like deadlines, which can be good stress. Episodic stress is high in intensity but short lived. Chronic stress, on the other hand, is both intense and sustained. 

Clinical Psychologist Dr. Kaile Ross says while we "are surprisingly resilient when coping with... short-term stress...chronic stress is likely to cause some degree of emotional exhaustion or burnout for most everyone." Burnout can manifest itself in all kinds of negative physical, emotional, and mental ways. To deal with those problems she recommends coping strategies that include reading and healthy social connections in addition to diet, exercise, and sleep.

Dealing with the constant stress of financial markets isn't much different than coping with the chronic stress of the COVID pandemic. My go to coping strategies for portfolio management include diversification, rebalancing, and factor investing. I have been doing these things from the beginning of my career and have consistently applied them ever since. I recall being interviewed by a prospective client in 1998 who was expecting a significant sum of money from the sale of his business. However, there were problems that stalled the sale until 2002, at which time he interviewed me again. I remember at the conclusion of the meeting he said that of the five advisors and brokers he spoke with in 1998, I was the only one who had the same story in 2002 that I did in 1998. 

While I can't speak to the inconsistency of the others, I can attribute my consistency to discipline. In Investing Psychology, Tim Richards says that advisors "...who exhibit better self-control are... less inclined to react to events and more inclined to stick with their strategies." In the late 1990s it was hard to resist the temptations of the dotcom stocks and stick with my long-term investment strategy. But I did, and it cost me some clients because I was making returns in the low teens, whereas the tech sector was generating returns of 50% and more. However, my self-control paid off in the early 2000s when my clients didn't go bust as the dotcom bubble was bursting. 

The vindication of the early 2000s was nice, but I am far prouder of what I did in 1996 through 1999, when I had the discipline to hold firm. It was during this period that an attorney asked how I could justify my fees since I wasn't "doing" anything. I replied, "I do discipline - and if discipline was easy you wouldn't be fifty pounds overweight." That wasn't very nice, but it was true because as Richards reminds us "...the ability to resist temptation [and] to exert self-control... is critical if we want to be better..." 

It turns out that if you want to be better at coping with the stress of a pandemic, it is important to have the discipline to eat right, exercise, and get a good night's sleep. Self-control is also necessary to be a better investor because it is not easy resisting temptation and sticking with a long-term strategy. Doing what you should do can run contrary to what you feel like doing. But I can attest to the long-term benefits of doing what the statistics say you should. It could be the difference between stability or going bust in retirement. So, before doing something rash, consider -- "What do you want for your retirement?"

Taking a personality test is an interesting experience. You find out that you are not alone. There is a whole segment of the population that is just like you. That can be either comforting or disconcerting, depending on your view of yourself. In my case, according to Personality Pathway's Myers Briggs personality test, I am an "introverted thinker" who ponders "the apparent chaos of the world in order to extract from it universal truths and principles that can be counted on." My wife is proof that opposites attract, because she is an "introverted feeler." So, while I am trying to build logical strategies, she is trying to build personal relationships. I want to understand the universe and she wants me to understand her. She trusts feelings and I trust reason. To me, logic and emotions have always been mutually exclusive. What has become disconcerting is that I have found they can also be mutually ineffective.

To even consider that there might be limits to the effectiveness of logic is a heretical thought that is a denial of my DNA. My mom, a Daughter of the American Revolution, always said that I inherited the Adams' nose and the Adams' arrogance. The hawkish beak adds to the air of aloofness. However, the arrogance is not based on an over-inflated ego, but on an unwavering belief that through hard work and perseverance an answer can always be found. So, problems fall into one of two categories: those that have been solved and those that are waiting to be solved. The French mathematician, physicist, and philosopher, Blaise Pascal, must have been in our group of introverted thinkers because he once said, "Reason is the slow and torturous method by which those who do not know the truth discover it."

So, while I gleefully proclaim the dangers of emotional responses to markets, I have to soberly admit that logical responses to markets can be just as ineffective. As Daniel Gross said in a web posting, How to Speak Hedgie, "Anyone who read the best seller The Black Swan knows that random geopolitical, financial and economic events can cause the prices of assets to move in ways that defy history and sophisticated computer models." And, may I add, logic. Gross points out that when markets crash money managers blame their problems on "irrational collective behavior" brought on because "investor fear has overtaken reason..." In other words, our decisions were logical and rational; it was the market that was irrational.

As a Myers Briggs "thinking" husband, I am embarrassed to say there are times when I think my Myers Briggs "feeling" wife acts irrationally. But that is more of a condemnation of my understanding of her than it is an accurate description of her. What appears to be irrational are really factors that I don't see, don't understand, or just don't pay attention to.

As a logical investment advisor, I likewise, understand that what appears to be irrational behavior of markets is caused by factors that I don't see, don't understand, or just don't pay attention to. And as much as I would like to believe it is a problem waiting to be solved, I know that, for all practical purposes, movements of markets are unknowable in advance. In hindsight it is easy to construct logical explanations of market gyrations. However, they are no better than the self-deceptive logical rationalizations I use to justify arguments with my wife.

As illogical as it sounds to me, there are problems that can't be solved. So, I need to relate to them based on universal truths and principles that are known to be effective. For markets, that means diversification and discipline, and for my wife that means back rubs and listening.

“You’d better be right or don’t bother coming in.” Those were about half the words, and the only repeatable ones, I heard in my headset from Chuck Will, the long-time producer of CBS golf telecasts as I stood on the side of the 18th green at Sahalee Country Club. It was near the end of the second round of the 1998 PGA Championship, and I had just radioed the production trailer that David Sutherland’s putt was for a double bogey, not a bogey, as the announcer had just reported on the air. Chuck’s expletive-laced response to my correction was so emphatic because whatever score Sutherland got was going to be the cut line for the tournament. If they went with my correction, and I was wrong, it was really a big deal since it would expose the network to ridicule from their rivals in the print media. “So, are you sure?” asked Chuck, “because we’re going with your call.” With conviction in my voice and doubt in my mind I said, “I’m sure.”

I’m relatively smart, I can count to six, and I clearly saw everything that happened. Why then would I have doubted myself? It’s simple. I always feel I am wrong because growing up I had a different way of doing things which meant I was constantly being told I was wrong. However, what started out as a weakness has turned into a strength, at least in my line of work as an investment advisor, as I have learned not to act on my feelings. 

I don’t act on my feelings when it comes to investing because of what I have learned from research in behavioral finance. According to Nobel laureate, Daniel Kahneman, in environments that are not sufficiently regular enough for someone to pick up and learn cues, expert intuitions cannot be developed. .He says the stock market is such an environment, which means feelings about market movements or stock price changes cannot be trusted.  

Since feelings cannot be trusted investors need to trust statistics. Unfortunately, the number aren’t perfect. They tell you what to expect. But that doesn’t mean the unexpected cannot happen, especially in the short run. That’s because of the uncertainty of markets. So, for shorter periods of time unexpected returns will often dominate expected returns. 

What is expected, in the long run, is that stocks with low ratios of price to book value (value stocks) will outperform stocks with higher ratios (growth stocks). Historically, for any 3-year period that is true about two-thirds of the time. But that’s not what happened for the most recent 3-year period. Instead of outperforming, value stocks underperformed by the largest amount since 1926. So, while the S&P 500 Index was up 10% (year to date) and Facebook, Apple, Amazon, Netflix, and Google were up a whopping 56%, value stocks were down 10%. That’s a concern for broadly diversified portfolios that balances both growth and value stocks, as we do. 

When such an outlier event happens, you feel like you did the wrong thing and need to make changes to correct the situation. But that would be “…wrong statistically,” says Kahneman because the long-term probability favors staying the course. However, as we have learned, probabilities are not guarantees and the unexpected is always possible.   

Stock markets are different than golf telecasts, so Chuck Will could demand right answers. Investors aren’t so lucky. They can only rely on long-term statistics, which means accepting the fact that you can’t always be right, so you need to be prudent. And prudence means sticking with the expected over the unexpected, especially in the midst of uncertain times that are exacerbated by the COVID-19 pandemic. So, with doubt in my mind and voice, but conviction in the numbers, I say, “I’m sure that we are doing the prudent thing by diversifying broadly.”

It was my sister Brenda’s birthday and her husband Jim, my daughter Hillary, and I were driving to meet her and the rest of my family at a restaurant on Maui. We were more than fashionably late because Jim had been practicing, and that was something he never rushed. He also was in no rush to get a card, so he picked one up at the last minute. Being his usual mischievous self, he gave it to Hillary, who was about 10, to write a note as if it was from him, with the instruction to “Write something mushy.” Being a kindred spirit with Jim, she agreed. The rest of the drive she dutifully worked on the task, occasionally stopping to ask how to spell a word – like “beautiful,” “special,” and “gorgeous.” 

The restaurant was on the ocean in downtown Lahaina. It was typical of many of the restaurants with at least one wall open to the air. I remember remarking, “you could not set a better temperature and humidity.” It was a perfect night. After dinner, Brenda opened her presents and read her cards. When she got to Jim’s card, her smile turned to a wide grin as she read it. When she finished, she looked up and said to him “That’s so sweet, but it isn’t your handwriting.”

Hillary and Jim were quite a pair. They were like twins - 45 years apart in age. They both seemed willing to try anything and do everything. I don’t know what Jim was like as a child, but Hillary was one of those kids who never learned by being warned or watching someone else’s mistake. She had to “do it” before she “got it.” She was the last of our three girls. Before she was born, people used to ask us how we did it – we were perfect parents. Then she came along, and no one ever asked us that again. She was always sweet, and she turned out fantastic, but she drove us crazy in the process.

“Insanity is hereditary. You get it from your children,” is a Sam Levenson joke. It’s funny – because it’s true. “Parenting is emotionally and intellectually draining… and any parent who says differently is lying,” confirms the Association for Psychological Science. Psychologists tell us that all this stress “translates into behavioral changes, loss of memory, inability for decision-making, and attention problems.” In other words, the stress of parenting makes us crazy, forgetful, stupid, and distracted.

The stress of stock market volatility seems to have similar effects. Somehow, psychologist Daniel Crosby quantified the impact. He concludes “The average investor loses 13 percent of their cognitive processing power during a period of financial duress." According to a Newsweek article, the stress of recent market volatility may be even worse because, “it involves fear not just about your money, but also fear about your health and the health of people you love. That adds an extra layer of anxiety." 

It’s a cruel quirk of nature that crazy markets make us crazy when it’s a time we most need to be sane. The Newsweek article – How to Stay Sane in a Crazy Market – stresses that somehow, “you have to steel yourself to ride out the periods when prices are slumping or, worse, plummeting.” One way of doing this, says Morningstar’s director of personal finance, is to differentiate “between volatility—that is, the short-term ups and downs in stock prices—and the threat of falling short of your savings goal because you didn't invest in assets that would earn the most in the long run.”

Thinking long-term is required for both investors and parents. Focusing on some of the nerve-wracking things our daughter did could have driven us crazy. But stepping back and thinking sanely, we could see that she was an important part of our family. I assume Jim’s parents felt the same way. It is also true for stocks. Despite the short-term volatility, the higher long-term returns stocks provide are essential for financial success. The real risk isn’t the short-term volatility of mischievous markets. It’s the craziness of volatile markets driving you crazy. So, you need to stay sane, even though markets are in no rush to act sane.