Reassurance In A Scary World
Why do so many investors, most of whom idolize Buffett, ignore his sage advice and listen to the advice of forecasters such as Faber? My 40 years of experience providing financial advice to corporations and individual investors has led me to conclude that one reason investors do so is there seems to be an all-too-human need to believe that someone out there can protect them from bad things.
The field of behavioral finance provides us with a second explanation. As humans, we are subject to confirmation bias. Confirmation bias is the tendency to search for, interpret or recall information in a way that confirms our pre-existing beliefs or hypotheses.
Thus, if we are concerned about an issue and someone forecasts a future in which what concerns us comes true, we are much more likely to act on that forecast (panic and sell) than if we were not so predisposed.
Compounding the problem of confirmation bias is what is known as prospect theory. We feel the pain of losses much more than we feel the joy from an equivalent gain. That leads to what is referred to as “myopic loss aversion” (short-term thinking to avoid the pain of potential losses).
I have learned that there are only three types of market forecasters: those who don’t know where the market is going (count me among them); those who don’t know that they don’t know; and those who know that they don’t know, but get paid a lot of money to pretend they do.
Thus, my recommendation is that the next time you hear some “guru” making a forecast, no matter how intelligent it sounds, no matter how cogent the arguments made, tune it out. Do nothing.
If you’re still tempted to act, ask yourself this question: Is Warren Buffett acting on the same information/forecast? And the answer, we know, is almost certainly that he’s not. So why should you? What do you know that Buffett doesn’t? Are you smarter than Buffett?
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.