Warburton Capital’s Evidence-Base Investment Insights
The Human Factor in Evidence-Based Wealth Management
So a buddy came in muttering “bitcoin…bitcoin…bitcoin”. Our buddy was kicking himself in the behind because he hadn’t loaded up on Bitcoin in 2009 when Kristoffer Koch – who was writing a thesis on encryption – bought 5,000 bitcoins for $27.00. (That works out to $0.0054 each. At todays ‘valuation’ for Bitcoin of just over $15,000 each, Mr. Koch’s investment of $27.00 is ‘worth’ $75,000,000.) Who among us would not like to have been on that train? Do I sense a consensus vote? Sadly – or perhaps not so sadly – as humans, we are destined to endure our perfect twenty-twenty hindsight. Perhaps it’s not all that bad?
That said, welcome to this the eleventh installment in Warburton Capital’s series on Evidence-Based Investment Insights: The Human Factor in Evidence-Based Wealth Management.
In our last piece, “What Has Evidence-Based Investing Done for Me Lately?” we wrapped up our conversation about ways to employ the evidenced based ‘premiums’ that exist in stock and bond markets within a disciplined investment strategy, as well as how to extract the diamonds of promising new evidence-based insights from the larger piles of misinformation. We turn now to the final and arguably most significant factor in your evidence-based investment strategy: The Human Factor. In short, our own impulsive reactions to market events that move us to action when inaction is appropriate.
Exploring the Human Factor: Despite everything we know about efficient capital markets and all the solid evidence available to guide our rational decisions … we’re still human. We’ve got things going on in our heads that have nothing to do with solid evidence and rational decisions. We are too often controlled by the brew of DNA inherited, chemically generated instincts and emotions that spur us to leap long before we have time to look.
Rapid reflexes often serve us well. Our prehistoric ancestors depended on snap decisions when responding to predator and prey. Today, our child’s cry still brings us running without pause to think; his or her laughter elicits an instant outpouring of love and, the chemical, oxytocin.
But in finance, where the coolest heads prevail, many of our base instincts cause more harm than good. If you don’t know that your instincts are taking over or don’t manage them when they do, your brain signals can trick you into believing you’re making entirely rational decisions when you are in fact being overpowered by ill-placed, “survival of the fittest” instinctive reactions.
Put another way by neurologist and financial theorist William J. Bernstein, MD, PhD, “Human nature turns out to be a virtual Petrie dish of financially pathologic behavior.”
Behavioral Finance, Human Finance: To study the relationships between our heads and our financial health, there is another field of evidence-based inquiry known as Behavioral Finance. This is the study of “What happens when we stir up that Petrie dish of financial pathogens?”
Wall Street Journal columnist Jason Zweig’s “Your Money and Your Brain” provides a very readable guided tour of the findings, describing both the behaviors themselves as well as what is happening inside our heads to generate them. To name a couple of the most obvious examples:
- When Markets Tumble – Your brain’s amygdala floods your bloodstream with corticosterone. Fear clutches at your stomach and every instinct points to “Sell The Losers!”
- When Markets Unexpectedly Soar – Your brain’s reflexive nucleus accumbens fires up within the nether regions of your frontal lobe. Greed grabs you by the collar, convincing you that you had best act soon if you want to seize the day. “Buy Bitcoin!”
An Advisor’s Greatest Role – Managing the Human Factor: Beyond such market-timing instincts that lead you astray, your brain cooks up plenty of other insidious biases to overly influence your investment activities. To name a few, there’s confirmation bias, hindsight bias, recency bias, overconfidence, loss aversion, sunken costs and herd mentality.
Our Take-Home: Managing the human factor in investing is another way a Fee-Based, Fiduciary, Evidence-Based Financial Advisor can add value. Zweig observes, “Neuroeconomics shows that you will get the best results when you harness your emotions, not when you strangle them.” By spotting when investors are falling prey to a Behavioral Bias, a skilled Financial Advisor can hold up an Evidence-Based mirror for them, so they can see it too. In our next piece, we’ll explore some of the more potent behavioral foibles investors face.
So, trusting you aren’t losing sleep over bitcoin and are inspired with confidence by your uniquely personal and Purposeful Financial Plan, we remain
Warburton Capital Management