In this week’s episode of Retire in Texas, Darryl Lyons, CEO and Co-Founder of PAX Financial Group, uncovers the surprising ways investors sabotage their own success. Despite strong market performance, studies show that the average investor consistently underperforms – by as much as 5% per year. Why? Behavioral biases.
Key highlights of the episode include:
•The Dow Bar study’s shocking findings on why investors consistently earn 5% less than the market.
•How overconfidence causes even successful professionals to make costly financial mistakes.
•Why recency bias leads investors to chase trends and panic during downturns.
•The impact of confirmation bias and how it keeps investors from seeing the full picture.
•Real-world examples of billionaires, fund managers, and everyday investors who fell into these traps.
For additional insights and to learn how PAX Financial Group can guide your financial journey, visit http://www.PAXFinancialGroup.com. If you enjoyed this episode, share it with someone who could benefit!
Transcript:
Hey, this is Darryl Lyons, CEO and Co-Founder of PAX Financial Group. And you’re listening to Retire in Texas. This information is general in nature only. It’s not intended to provide specific investment, tax, or legal advice. Visit PAXFinancialGroup.com for more information. So, as always, I want to remind you that you can click on the Connect Now button at the very top of PAXFinancialGroup.com.
And if you want to connect with an advisor that has a heart of a teacher, it’ll be a 15 minute conversation just to see if we’re a good fit. So, some of you guys out there might be needing an advisor, or just want to just kind of check to see if you’re doing the right thing. Our advisors are absolutely awesome.
So, I think you’ll appreciate a 15-minute conversation. It doesn’t cost you anything. And the guys and gals that are at PAX, the advisors here, they’re really sincerely good people. Okay. So, you know, with the recent airline crash, American Airlines, the, regional jet that collided with the Black Hawk helicopter, was devastating. Plunging both of the aircrafts into the Potomac.
I was having a conversation with my daughter, Lucy. She’s 11, and, you know, we were listening to the news and all that, and then she asked about us traveling. We’re going to go on a trip and go on an airplane. And so, you can see the look on her face when she realized that we were going to go on an airplane and just the idea is, is it safe?
It was just kind of floating through her head right then and there. And I think that is a normal human reaction. Like, that’s just how we all operate. Logically speaking, we know it’s safer. The National Safety Council states this all the time that it’s safer to fly than it is to drive. But we get this recency bias that makes us really, really nervous.
And that fear is very real, and it messes with our logic. In fact, it’s probably safer post-crash because of the hypersensitivity to safety. But we still get this kind of nervousness that’s human nature that says, is it in fact safe to fly? When logic and facts tell us it is. And I am going to unpack three of these human behaviors, these biases that exist in our investment experience that you need to know about because they mess with your head, and they mess with your money.
I feel like I have a little bit of a calling to a certain degree to help resolve this problem that’s existed in our investing experience as investors for many, many years. Dow Bar does a study, and they’ve done it since 1985. And they look at the difference between investment performance and investor performance. And it’s different.
So, you can look at charts and I can show you a chart of investment and say this investment has earned 10% every year on average since 1950 or whatever, but they are able to actually look at client statements and say, did those clients actually earn that money? So, it’s kind of a cross-reference. And the problem is, the clients typically don’t earn that same return that is shown on the company websites because clients tend to get in and out at the wrong time.
So, in fact, this is 2023’s Dow Bar study, 2024 hasn’t come out yet. 2023 showed that investors earn 5% less than the market because of bad behavior. That’s 5%. That’s huge. This is what Dow Bar says. Investors tend to sell out of investments during downturns and miss out on rebounds. The report illustrates the importance of a long-term investment strategy.
You know, going one step further, Peter Lynch, you may or may not know that name, but he ran this fund called the Fidelity Magellan Fund from 1977 to 1990. It was an incredible fund. Under his management, the average rate of return on that fund was 29%. So, all you had to do was just, like, hitch on the back of Peter Lynch and you were doing great, phenomenal returns.
He was a stud in the industry, but according to Fidelity, this is absolutely insane. The average Magellan Fund investor lost money while Peter was there. So, the average rate of return was 29%, but the average investor actually lost money. Because they get in and they get out. It’s absolutely insane to me. Benjamin Graham, a famous investor, said the investor’s chief problem and even his worst enemy is likely to be himself.
The investor’s chief problem, and even his worst enemy is likely to be himself. So, let’s unpack these biases, rooted in this area of study called behavioral finance. Often, I have referenced Daniel Kahneman and his work in this space, but overconfidence is the first one I want to talk about. And I selected these because I, you know, probably selected them because I struggle with them.
So, I have to recognize these biases even in me. Overconfidence, you know, this is tough because we do have a lot of successful clients, clients that have had very successful careers in business or medicine or whatever, and they’ve done really well at their craft. They’ve been Executive of the Year, entrepreneurs, they’ve led teams, they’re very, very talented. And so many times, and I don’t fault them.
They would think that they could take the skill sets that they’ve learned over the years, and it would translate into managing their own money. I am so thankful to their wives. I’m so thankful to their wives. We just have this idea that we’re better than we really are. And the American Automobile Association reminds us of, that 78% of Americans consider themselves better than average drivers.
And I think that’s the same when it comes to investing. So how do you resolve this? How do you resolve this overconfidence? How do you try to like you don’t, nobody says I’m overconfident. You know, go out there and say, yeah, I’m overconfident. You just kind of almost have to assume you’re overconfident. If you’re starting to think I can figure this out, I think you want to have some play money.
I have one client that has play money on the side, and I love it. And sometimes his play money just absolutely destroys everything we’re doing because it’s a little bit more concentrated. So, there’s seasons in which concentrated portfolios do better. And then sometimes we do better. And it’s just a healthy tension.
But it’s different when you put zeros on money. The decisions you make are different. So, but I think having some play money, if you’re overconfident, having some play money is good for you. I don’t think there’s any problem with that at all. I’ve got play money and it’s kind of one of those things where if I lose it.
I’m okay. And I think that’s just healthy for all of us, especially when we have overconfidence. You know, overconfidence is frankly, it’s a function of lack of knowledge. The more ignorant you are, the more confident you are. Right? And so spend some time learning the details of whatever craft you’re considering because overconfidence hear me out.
Overconfidence precedes carelessness. You know, there’s this guy named Bill Hwang – Hwang. He ran this hedge fund. And you see these guys. And if you see them and talk to them, you’re like, this guy is brilliant. He’s amazing. And usually, they are. They’re like, they have these pedigrees, you know, Harvard, Yale did it all.
Knows all these people. But what you never, ever know. This is hard, right? When it comes to business, you never know when this smart, brilliant person is overconfident. And sure enough, this guy, he ran this incredible fund, he was buying all these stocks like Discovery and ViacomCBS. I mean, he was killing it. In fact, he was doing so well.
We’re not talking like hundreds of thousands or millions. We’re talking about billions of dollars. Goldman Sachs said, we want to give you money, Morgan Stanley, we want to give you money. Credit Suisse, they all gave him a bunch of money. They all lent him money because he would borrow from these banks, and then he would go and buy stocks.
So, you know, leverage can be bad, right? When you borrow too much money, the borrower is a slave to the lender. We’ve heard that. But this guy was super confident, overconfident. And eventually in March of 2021, it all came crashing down. All of it. And he lost tens of billions. He ended up going to jail. You just never see that stuff.
You just see all the LinkedIn profiles. You never see that overconfidence. And I think for me personally and for others, I think we just always have to say, you know, we’re subject to being overconfident and we need to, maybe if we’re going to try something, we try it on a small scale. Jim Collins says fire bullets, not cannons.
And then, also surrounding yourself with people that that may be able to put you in check. Wives are real good at that. I keep saying that because it’s often the men that have the overconfidence by the way. And then, of course, education. So those are some of the tools that can help guide you as you navigate through overconfidence.
Okay. The second one is recency bias. This is one that, again I’m subject to these things too. And this is similar to the airplane situation that we just talked about. But in investments it happens a lot. It’s happening right now more than ever. I was talking with somebody the other day and they were just talking about, you know, Nvidia and Apple and, you know, we talked about the Magnificent Seven and it’s so easy to look at the last 1 or 2 years and say, you know what I’m doing, it’s not working, and I need to switch.
And then in fact, I was looking at charts yesterday and it was very tempting. I’ve got, you know, this one portfolio that’s just hasn’t been working for the last couple of years. It’s very tempting to say, okay, it’s time to switch. And guess what happens when you switch? Yeah, it starts working. And so, it’s so tempting to look at the flavor of the month and recent news.
You know, this is part of the recency bias, you will anchor to recent news like will see a headline or, you know, here’s something about performance from some company and that will just stick in our head. And we will run with it. We already made this mistake as investors in the tech bubble in the 90s.
I started in the business in 99 and this was the internet craze. You could, if you were a tech company, you were.com. You could do no wrong. There were companies like Pets.com, WebVan, EToys, all their stock prices shot up. One company that you may or may not remember, I’m sure you do is Cisco.
And Cisco, that was one of the tech giants. And again, they could do no harm. And they killed it until they stopped killing it. And then they lost, their stock went down 86%. And if you’re recency biased, you would have put all your money in there, probably after the run up, hoping that you would be able to catch another run up on that Cisco stock, but only to have lost 86%.
It did recover, but it took 15 years to recover. Okay. Last bias I think is important. This one again. So, I’m subject to confirmation bias. You’re looking for information that supports your belief in dismissing altogether contradictory evidence. You see this a lot in politics, right? And you’re like, yes, my brother-in-law, he’s you know, he’s always sending me information about so and so, you know, whatever administration.
And I give him information, but he just dismisses it. Yeah. And that’s confirmation bias at its best. And it happens in investments too. Especially it happens a lot when the market goes down because you start hearing a lot of things. And it just kind of reinforces this theory that you have that the world is falling apart.
And Glenn Beck tends to, you know, add fuel to the fire and the gold salespeople add fuel to the fire, this whole thing’s falling apart. And you have this theory that it is falling apart. And then it’s just being reinforced by the media. And so that confirmation bias is something that we’ve got to be very careful of. Again, I can easily have a theory and find information to support my theory.
I can do that pretty well. My challenge on a go forward basis to be a better leader for our community is to start identifying contradictory information. And I’ve been able to do that recently. Probably more so I say recently, more so in the last five years. But I’d say early, I got to be careful.
I’m still not in this space, but confirmation of what my thesis was what I sought out. But now, it’s so important that I look at the other side of the coin, and it’s so important for you to look at the other side of the coin. Tesla is a great example. Tesla, I remember this, but Tesla, when they first started out, there were not just headlines but a lot of talking heads.
Were talking about like manufacturing problems like production delays with Tesla, financial losses. They would miss deadlines. I remember hearing all of that. And there was another group of people that dismissed that and saw its long-term potential, and they saw a growing customer base. They saw leadership making good decisions. And those people that didn’t simply discount Tesla, that weren’t subject necessarily to confirmation bias, maybe they were in their right.
Obviously. But they ended up making a ton of money because Tesla took off about 2020. But I know a lot of us, me included, you know, just saw that debt missing deadlines and production issues and part of it is a bias for, you know, this new idea of energy and who’s going to buy cars that are electric.
So, we just have to be careful with all of these confirmation bias that exists. And so, getting contradictory information, asking yourself what evidence would convince me that I’m wrong, here’s a quote that I think is really powerful. The greatest, hear me out. The greatest enemy of knowledge is not ignorance. It is the illusion of knowledge.
The greatest enemy of knowledge is not ignorance. It is the illusion of knowledge. So here we have this real problem. The Dow Bar study just continues to reinforce this problem, that investments are doing one thing, and investors are doing something else. I really feel that having an advisor relationship really mitigates that risk of you as an investor, getting in and out at the wrong time, it just hold you accountable to staying the course.
And so, I thank you for your trust. For those that use PAX, for those who are using an advisor, just know you’re getting your money’s worth. If that individual is helping you stay the course, because there’s a big gap between investment performance and investor experience. And we need to close that gap. And we do that just by recognizing these biases that exist.
Just recognizing them is pretty much 90% of it. And then from there making sure that we have that humility of making decisions that aren’t rooted in overconfidence, or confirmation bias or recency bias. And I do want to leave you with this one quote. I think this is the quote that I want to double click on.
That’s Benjamin Graham’s quote – The investor’s chief problem, and even his worst enemy is likely to be himself. And that won’t be you because you’ll be thinking long term. Have a great day.
Resources:
Keys to Financial Success and how Behavioral Tendencies can Impact…
Is It Safer to Travel by Car or Plane? A Comprehensive Safety Comparison for Travelers
DALBAR Releases 30th Annual QAIB Report
How Investors Are Costing Themselves Money
5 Behavioral Biases That Affect Investing Decisions
Listen on:
