At the Money: Changing Your Behavior For Better Investing



At The Money:  Changing Your Behavior For Better Investing (July 3, 2024)

If you could change only one thing that would help your investing, what would it be? Your own behavior. When it comes to investing, we are our own worst enemies. Why is this, and what can we do to avoid this fate? Neurologist and professional investor Dr. William Bernstein explains how to manage our emotions to avoid poor outcomes in markets.

Full transcript below.


About this week’s guest:

Dr. William Bernstein is the author of numerous books, including “The Four Pillars of Investing: Lessons for Building a Winning Portfolio.” He manages client assets ($25m minimum) at Efficient Frontier Advisors.

For more info, see:

Professional website


Masters in Business



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Transcript: Change Your Investment Behavior

If you could change only one thing that would help your investing, what would it be? The  answer. Your own behavior.

We humans are a mess of biases and poor decision-making. We only read or watch things we agree with. We forget our worst trades and we allow our emotions to get the best of us. We are filled with unjustified overconfidence in our own abilities.

As it turns out, when it comes to investing, we are our own worst enemies.

I’m Barry Ritholtz, and on today’s edition of At The Money, we’re going to discuss how to best manage our own behavior for the health of our portfolios. To help us unpack all of this and what it means for your portfolio, let’s bring in Dr. William Bernstein. He is both a neurologist, and a professional investor. He is the author of numerous books on investing, perhaps most famously, “The Four Pillars of Investing: Lessons for Building a Winning Portfolio.”

So Bill, let’s start with a simple observation from your research. When it comes to making risk allocation decisions in capital markets, we just ain’t built for it. Explain.

Dr. William Bernstein: Well, Barry, our late Pleistocene ancestors evolved in an environment with a risk horizon that was measured in seconds, sometimes fractions of a second. Whereas in the modern era, our financial risk horizon extends a half a century or so. So in short, we are living in the space age with Stone Age brains.

Barry Ritholtz: So let’s delve into those Stone Age brains and how its evolutionary development leads us Australian in modern capital markets. What is it that our wet wear does to us?

Dr. William Bernstein: Well, my favorite analogy is what I call the skunk analogy, which is over the past 10 or 20 million years, skunks of all a very effective strategy for dealing with large predators, which was to turn 180 degrees, lift their tails and spray.  And that’s very effective until they find themselves in a semi urban environment where the biggest threat to their existence is a two-ton hunk of steel moving at 60 miles an hour. That is exactly the wrong strategy.

It’s the same way with investing. When we mess up and we want to distance ourselves from our mistakes, we panic and we sell, which most of the time is the wrong response.

Barry Ritholtz: I love this quote of yours “To the extent you succeed in finance, you succeed by suppressing the limbic system, the very fast moving emotional system. If you cannot suppress that, you’re going to die poor.” Explain that to us.

Dr. William Bernstein: Well our system one that is our Crudely speaking our reptilian brain is where our fear and our greed live So so to give you a simple example, we evolve to think well of ourselves And to feel shame and disgust when we fail which is a very effective evolutionary strategy in the late Pleistocene environment and unfortunately when we make a mistake in investing we buy it You know, a stinko asset.

We try to distance ourselves from it by selling in the pen in a panic now at the level of individual securities that may or may not be an effective response, but at the asset class level, it’s generally best when you buy a bad asset class to either hold firm or to buy more.

Barry Ritholtz: Let’s get into some more details about that. You observe the single most important determinant of one’s long term success is one’s behavior during the worst 2% of markets. Why is that?

Dr. William Bernstein: You can think of investing metaphorically as a highway on which you drive your assets from your present self to your future self. And most of the time the driving is pretty smooth. The road is pretty good.

But occasionally they’ll suddenly run into a massive. Pothole or a blind curve on a dangerous mountain pass with no guardrail, and that’s the worst 2% of the time. So in general, the slower you drive, that is more conservative your portfolio, the more likely you are to convey those assets from your present self to your future self, that is to compete to complete the journey.

And the message there is to invest more conservatively than you think you should, because 2% of the time, it’ll prevent you from bailing from a very effective long term strategy.

Barry Ritholtz: Let’s talk a little more about that 2%.  I imagine the worst times for investor behavior is either at the very top of a bubble where people have a tendency to have FOMO and pile in, or at the very bottom of a market correction or crash, where people panic and capitulate and just dump everything at the low’s. What, what’s your experience been?

Dr. William Bernstein: My experience is the bottoms. That’s, that’s more important. When I talk about the worst 2% of the time I’m talking about, you know, 2008-09, I’m talking about 1973-74, or 1931-32, if you’re familiar with that history.

Compounding is magic, but you have to observe Charlie Munger’s prime directive of compounding, which is to never interrupt it. That’s what you’re trying to prevent. You’re trying to prevent yourself from interrupting that the magic of compounding. And you do that by paying attention to the worst 2% of the time and to design your portfolio with that worst 2% of the time in mind.

Barry Ritholtz: Very interesting. Let’s talk about one of the other issues that overconfidence seems to lead to, and that’s glamour stocks. People seem to be seduced by these. It used to be Amazon, then it was Apple, then Tesla, today it’s NVIDIA. Why are we so taken by these household names that have had tremendous run ups in the market?

Dr. William Bernstein: The economic historian, Charlie Kindleberger said it best about a half century ago, which is “There’s nothing so disturbing to one’s wellbeing and judgment as to see a friend get rich.”

And that’s the problem with, with glamor stocks. Put another way, the history of stocks of companies with revolutionary technologies that sell at stratospheric multiples. It’s an unhappy history. Generally you wind up, uh, not doing terribly well when you do that.

Barry Ritholtz: Another quote of yours that I love: “The advent of free trading is like giving chainsaws to toddlers.” Explain.

Dr. William Bernstein: In the first place, commission free trading can be an advantage, just like a chainsaw can be a marvelous tool if you use it properly. So how do you use the chainsaw of free trading and low expenses effectively and safely? Well, you do it by buying and holding low cost ETFs in an index funds.

How do you use free trading improperly like a toddler with a chainsaw? Well, you trade stocks and even worse options all day long. If you’re trading options all day long on a free platform, your wealth is going to melt like ice on a hot pavement.

Barry Ritholtz: Let’s talk a little bit about that overconfidence. Do most of us really believe we’re smarter than the market? Do we really think we’re Stock picking or market timing geniuses.

Dr. William Bernstein: We sure as heck do that. Uh, whenever you trade a stock, you’re saying that you’re smarter than the person on the other side of the trade, which is generally not true. And when you think that you can time the market, you’re saying that you’re smarter than the collective wisdom of the market, which is not true more than 90% of the time. And if that’s not overconfidence, I don’t know what is.

But there’s an overconfidence that’s even worse than the overconfidence of stock picking and market timing. And that’s overconfidence about your risk tolerance at the top of the market. Everyone’s a long term investor, and they don’t take to heart my favorite quote from Fred Schwed’s marvelous book, “Where the customers yachts?” Which is that “There are certain things that cannot be adequately explained to a virgin, either by words or pictures, nor can any description I might offer here even approximately what it feels like to lose a real chunk of money that you used to own.”

And that’s what you run into when you’re overconfident about your ability to tolerate risk,

Barry Ritholtz: To say the very least. So there are a couple of other things in some of your books that really stood out when it came to human psychology. And one of the things that jumped out was, very often we rely on conventional wisdom when the conventional wisdom is very often wrong. How does conventional wisdom lead us astray?

Dr. William Bernstein: The conventional wisdom at a general sense is very often right. Conventional, but conventional market wisdom that you need to diversify, keep your expenses down, and that there’s a connection between risk and return. Those are all generally true.

But where conventional wisdom falls down is when it comes to specific securities. And that’s for one simple reason. The more favorably disposed the investing public is to a given, stock, the more its price has been driven up. And so the lower its future expected returns. Now, the converse is true of universally reviled assets. The time to own junk bonds, for example, is when the term becomes an epithet that’s spat out of the speaker’s mouth.

Barry Ritholtz: One of my favorite Twitter accounts is called TikTok Investors and this person pulls the most ridiculous investing strategies from TikTok  and shares them. The one I saw this morning was this woman who uses tarot cards to help her select option trades. You could tell by her demeanor, she really believes that this is useful and going to be a long-term win.

Dr. William Bernstein: Yeah, one of my favorite quotes from Larry Summers, it’s a short and pithy one, which is, “There are idiots, look around.”

Barry Ritholtz: How can we overcome psychological biases to make better and more rational investment decisions?

Dr. William Bernstein: First of all, you trade as little as possible. And secondly, you sort of psychologically internalize the Tobin separation theory, which basically separates out asset classes by how much risk they have.

In the Tobin separation theorem, there are only two asset classes. There’s the risky one, which is stocks, which has high returns. And there’s the safe one, which has low, low returns. And so the key thing is to cleanly separate those two things in your mind, and you do that by making sure that your riskless assets really are riskless.

When the experiment hits the ventilating system, corporates, and even municipal bonds are going to make you, take a haircut on those holdings. If you want to use them to buy cheap stocks or simply to pay for Your, your groceries. Another way of saying that is there’s a reason why Warren Buffett keeps 20% of Berkshire in T-bills and cash equivalents.

Barry Ritholtz: Sounds like you’re describing the 60 40 portfolio.

Dr. William Bernstein: There’s nothing wrong with the 60/40 portfolio. You know, once every couple of years, you’ll see a headline that the 60/40 portfolio is dead. And you know, I think that anybody who says that needs to wear a sandwich board that says, I don’t know what I’m talking about.

Barry Ritholtz: The last time that was said was right before, um, a pretty substantial move down in equities. Although to be fair, there was a modest move down in bonds as well.

Our final question, how best should we manage our own investment behavior?

Dr. William Bernstein: There’s as we alluded to earlier, there’s system one, which is your, you know, your emotional reptilian brain and their system two, which is your inner Mr. Spock, your logical, internal, processes.

The trick is to train your system to your logical system, to listen to your system one and to learn when it’s acting up. And I’ve, I found, for example, That the most profitable purchases I’ve made have been accomplished when I felt like I was about to throw up.

Barry Ritholtz: I know the feeling.

To wrap up, overcoming our own psychology and making rational decisions is the key to long term success in the markets. Avoid trying to pick glamour stocks, avoid market timing, and most important of all, avoid giving in to your emotions when things get dangerous. Stay with your financial plan, invest for the long term, and you’ll be fine.

I’m Barry Ritholtz, and this is Bloomberg’s At The Money.




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