Shownotes
In this episode of Investment Strategy Made Simple (ISMS), Andrew gets into part two of his discussion with Larry Swedroe: Ignorance is Bliss. Today, they discuss two chapters of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this thirteenth series, they discuss mistake number 24: Do You Believe More Heads Are Better Than One? And mistake 25: Do You Believe Active Managers Will Protect You from Bear Markets?
LEARNING: Invest conservatively instead of following the crowd. The best way to minimize the risks of a bear market is to hyper-diversify.
“The only way to help minimize those risks and be safe is not to take risks, but then, you won’t get any actual returns, and it’ll be hard to reach your goals. The next best thing is to hyper-diversify.”
Larry Swedroe
In this episode of Investment Strategy Made Simple (ISMS), Andrew gets into part two of his discussion with Larry Swedroe: Ignorance is Bliss. Larry is the head of financial and economic research at Buckingham Wealth Partners. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.
Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss two chapters of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this thirteenth series, they discuss mistake number 24: Do You Believe More Heads Are Better Than One? And mistake 25: Do You Believe Active Managers Will Protect You from Bear Markets?
Did you miss out on previous mistakes? Check them out:
- ISMS 8: Larry Swedroe – Are You Overconfident in Your Skills?
- ISMS 17: Larry Swedroe – Do You Project Recent Trends Indefinitely Into the Future?
- ISMS 20: Larry Swedroe – Do You Extrapolate From Small Samples and Trust Your Intuition?
- ISMS 23: Larry Swedroe – Do You Allow Yourself to Be Influenced by Your Ego and Herd Mentality?
- ISMS 24: Larry Swedroe – Confusing Skill and Luck Can Stop You From Investing Wisely
- ISMS 25: Larry Swedroe – Admit Your Mistakes and Don’t Listen to Fake Experts
- ISMS 26: Larry Swedroe – Are You Subject to the Endowment Effect or the Hot Streak Fallacy?
- ISMS 27: Larry Swedroe – Familiar Doesn’t Make It Safe and You’re Not Playing With the House’s Money
- ISMS 29: Larry Swedroe – The Shiny Apple is Poisonous and Information is Not Knowledge
- ISMS 30: Larry Swedroe – Do You Believe Your Fortune Is in the Stars or Rely on Misleading Information?
- ISMS 34: Larry Swedroe – Consider All Hidden Costs Before You Invest
- ISMS 35: Larry Swedroe – Great Companies Are Not Always High-Return Investments
Mistake number 24: Do You Believe More Heads Are Better Than One?
One of the things Larry tries to teach people is about conventional wisdom when it comes to investing. Conventional wisdom is things that are generally accepted that no one questions because they typically apply in most fields.
Larry says that the problem with using conventional wisdom when investing is that investing is a very different endeavor because you’re not competing one-on-one against someone; you’re competing against the collective wisdom of the market. And the conventional wisdom is that more heads are always better than one. But when it comes to investing, too many cooks spoil the broth; therefore, more heads are not better than one.
To illustrate this, Larry quotes a study by professors Terrance Odean and Brad Barber, Too Many Cooks Spoil the Profits: Investment Club Performance. The study covered 166 investment clubs, using data from a large brokerage house, from February 1991 to January 1997. Here’s a summary of their findings, which include all trading costs:
- The average club lagged a broad market index by 3.8% annually, returning 14.1% versus 17.9%.
- 60% of the clubs underperformed the market.
- When performance was adjusted for exposure to the risk factors of size and value, alphas (performance above or below benchmark) were negative even before transaction costs. After trading costs, the alphas were, on average –4.4% per year.
Larry’s advice is to invest conservatively instead of following the crowd. Diversify your portfolio, make any big bets, and you’ll be fine.
Mistake number 25: Do You Believe Active Managers Will Protect You from Bear Markets?
Larry admits that active managers start with an advantage headed into a bear market because the passive systematic investor is going to earn the return of the market; they’re not getting in and out of the market. The market may have done very well before the bear market. They would have rebalanced their portfolio, taken some of those chips off the table, and sold high. And when the bear market hits, if they stay disciplined, they get to buy low and can even outperform the very funds they invest in.
But active managers tout themselves to have the ability to get you out before the bear emerges from its hibernation and will get you back in before the bull gets into the arena again. So they can move to cash. However, there’s no evidence that active managers can protect you from bear markets.
Larry says the only way to help minimize the risks of a bear market and be safe is not to take risks. But then, you won’t get any actual returns, and reaching your goals will be hard. The next best thing is to hyper-diversify.
About Larry Swedroe
Larry Swedroe is head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.
Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.
Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.
Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.
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Connect with Larry Swedroe
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- How to Start Building Your Wealth Investing in the Stock Market
- My Worst Investment Ever
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Further reading mentioned
- Larry Swedroe and RC Balaban, Investment Mistakes Even Smart Investors Make and How to Avoid Them
- Philip E. Tetlock, Expert Political Judgment: How Good Is It? How Can We Know?
- Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the Life-Changing Science of Behavioral Economics
- Larry Swedroe, Think, Act, and Invest Like Warren Buffett: The Winning Strategy to Help You Achieve Your Financial and Life Goals