The lead article in the current issue of National Geographic, “Why Do Many Reasonable People Doubt Science?” is worth a read for those bewildered why more people haven’t embraced the science of investing. Many investors still seem willing to pay high fees for professionals to try to beat the stock market when the evidence demonstrates that investment returns are driven by risk and that the best strategy for individual investors is to buy and hold the market by building a sensible and diversified portfolio suitable to their risk tolerance using low cost investment funds.
Researchers point out that while most people are more than happy to accept the findings of science, we still tend to hold on to more basic intuitions, or what the researchers call our naive beliefs. No matter how strong the scientific evidence we tend to continue to use these naive beliefs as the principle mechanism for helping us to make sense of the world around us. Interestingly what we choose to believe is more often driven by how we choose to believe rather than the belief itself. While science itself appeals to the rational side of the brain, beliefs are driven more by the emotional side and most often driven by our need as humans to fit in with those around us. As the author puts it, “For some people, the tribe is more important than the truth.” Furthermore, the research suggests that even when science literacy is increased, rather than rationalizing entrenched beliefs it actually just polarizes them further as people tend to use scientific knowledge to reinforce their beliefs, rather than to challenge them.
The science of investing is very compelling and the evidence is clear, but is up against some fairly powerful beliefs, emotions and behaviours that get in the way. We’ve identified a number of reasons why beliefs might be getting in the way of good science when it comes to investing:
1) Money is very emotive. Whether you like it or not, money is an important part of life, but can also be a source of strained emotions or stress. Do I earn enough money to support my living expenses? Will I have enough money to retire or to pay for my children’s university? How come those people have so much more money than we do? How can I get rich by investing? These are real questions than can inspire strong feelings of fear, of greed, even just a strong desire to do the best you possibly can. The investment and infotainment industries know that money is emotive for people and market to them accordingly.
2) We buy lottery tickets and go to Las Vegas. The appeal of winning it big can be very seductive and the investment industry again is very adept at marketing to your emotional brain. For some people, the excitement surrounding a long shot win is an emotion that needs to be satiated. Gambling in a casino, buying a lotterty ticket or speculating with your money by giving it to someone who promises superlative investment returns shouldn’t be confused with a sound investment approach.
3) Proactivity vs passivity. Society doesn’t like the idea of passivity, certainly not as the best way to achieve a goal. It just seems like you should be doing something more – however in the case of investing, the evidence suggests that the best course of action is simply to be invested in the market in an intelligent way, not try to outsmart it.
4) We like winners. Everyone listens to the winners, and the winners get to write their story. The challenge with investing is that in most cases it is virtually impossible to distinguish whether winners are there because of skill or luck and it’s nearly impossible to identify winners in advance. Even in a coin toss someone is going to get 10 heads in a row if you have enough tossers. In the case of investing, those rare winners are praised for their wisdom, get interviewed on CNBC, write books on their winning strategies and, yes, attract more money from investors.
5) We want the best for our kids – “Passive investing? This is our children’s future we’re talking about. I don’t want Walmart, I want the Ferrari of investment funds.” This is a direct quotation from a particular discussion from our past investment careers that we think speaks for itself. The reality is that in the field of investments, the Ferrari just costs more, it doesn’t get you there any faster.
6) We seek expert advice in other walks of life – if you have an injured knee, for example, you seek out the best possible doctor with the most training, skill and experience. Investing is an area where applying additional resources, training or experience doesn’t necessarily positively impact the end result. Those in the investment industry who say they have the skill, training and experience to beat the market are ignoring the evidence. The evidence suggests that accessing the market through low cost investment vehicles like ETFs and low cost mutual funds is better than trying to beat the market.
When it comes to investing, the science is compelling but the beliefs that influence behaviour are powerful. Furthermore, the investment industry is aware of these beliefs and very persuasive in its attempts to have you focus on them rather than the science.