Looking Into A Mirror - Not Out The Window

July 1, 2019

“You can trust what he says, just don’t watch what he does.” It wasn’t a derogatory remark - it was an honest opinion. And the fact that it was expressed by a PGA club professional gave it validity.

John and I played a fair amount of golf together until time commitments and changing work schedules made it difficult to coordinate tee times. However, when we were playing together it was usually as a twosome, so we were often paired with a couple of strangers. On this particular occasion I made a suggestion to one of our playing partners - and John, while not discounting the helpfulness of my tip, felt obligated to warn the guy that I wasn’t very good at practicing what I preached.

Thinking back about this reminds me of the similarities between my behavior and that of investment advisors, as described by one of my favorite authors, Jason Zweig, in a blog about a speech he gave on behavioral finance. He “…suggested that many people who try to apply psychological findings to the financial markets do it backwards: instead of studying their own biases and failings, they focus on those of other people.” He says by doing this you are doing a great disservice to yourself, your clients, and your business because you are viewing “…behavioral finance mainly as a window onto the world. In truth, it is also a mirror that you must hold up to yourselves. More worrisome, it is a mirror that magnifies and clarifies and highlights your own warts and imperfections.”

Through the window of behavioral finance investment advisors see the investing public’s weakness for certainty in an uncertain world. However, without the mirror of introspection, advisors fall prey to the same weakness. And in some ways advisors are even more susceptible. As Zweig warns, overconfidence is often an expert’s biggest weakness. “In short, the more you know, the more you think you know than you really do.” Unfortunately, this overconfidence sits well with a client’s need for certainty, but it “…rests on [an insecure] foundation: our almost unlimited ability to ignore our ignorance,” explains his mentor Daniel Kahneman in his famous book, Thinking Fast and Slow.

An investment strategy built on such a foundation causes real problems because clients are often not willing to accept short-term underperformance to achieve long-term success. It is how the industry and advisors have, in effect, trained clients. As Zweig clarifies, “How you market… becomes[s] an inextricable part of how you invest.” Emphasizing short term performance encourages clients to focus on recent returns, which limits the advisor’s options. To avoid client discontent and loss of business, advisors become more concerned with how their portfolios track with the major indices than implementing strategies that enhance the probability of long-term success. That’s why, to be able to implement long-term strategies, advisors must encourage long-term thinking and emphasize disciplined behavior.

Zweig believes investment success is more dependent on character than knowledge. “On whether your firm can show the resolve to stand out from the herd and to stick to your strategy…” even when it is out of favor. That happened in the late 1990s when our globally diversified, small, and value strategy under-performed - and it is happening again today. But, in Zweig’s words, our knowledge of how to invest smarter was and is only worthwhile because of our willingness “…to endure the short-term pain of being right in the long run.” And the only way to be able to do that is by looking into a mirror at your own imperfections, instead of gazing out the window at the weaknesses of others. So, unlike my golf advice, you can trust what I say about investing because it is exactly what I been doing for the last 25 years.