If I had to do it all over again, I would have studied for a master’s degree in psychology and finance. To fill that gap, we read constantly in various industry periodicals the latest in research with regard to the markets, asset allocation and the role of behavioral finance. To this end, we will share with you a snippet from our “Portfolio Construction, Management, Philosophy & Process” -
“BEHAVIORAL FINANCE
It is human nature that there are two voices in your head. There is the logic, and there is the emotion. You can think of it as the two people on your shoulders shouting at you what they think you should do. Logic tends to be longer-term, more rational, and well thought out, whereas emotion is something that we feel over a shorter-term period. And what is interesting is most people make decisions based on their emotions. This is where a good advisor is critical, they help clients to be more rational, to offset some of the pressure that comes from the short-term emotion by saying, “No, I know you are feeling this way, but history and logic tells us to stay with the plan.”
Further to client education, from our study of behavioral finance, we do not think humans are wired to think in long-term increments, and so, in our business, we sometimes must advance what is counterintuitive to our clients. Unlike any other service that you receive, where you can evaluate the outcomes over short time frames…for example, you go to the dentist and it is clear whether your dentist knew what they were doing, and so you make the decision based on that one outcome whether or not to go back. Whereas, with your financial advisor or when you are looking at market outcomes, there is so much noise in terms of any particular outcome relative to whether something is working or not, that it drives people to make decisions on a short-term basis, like they do in every other aspect of their lives. And it is very reasonable to do this with most services and products you receive in life. However, in the markets, if you simply do the thing that is working and avoid the thing that is not working, you may end up with the worst possible outcome. This is difficult for most people to do in a disciplined way without a good advisor to help them understand the implications of emotional decision making. We frequently present clients with multiple alternatives to their portfolio construction, each with different risk and reward characteristics. Which one is best? We will not know for years until we have the benefit of hindsight…and the answer may be different depending upon whether the look back period is 3-5-10+ years. As an example, if we use one of the world’s most famous investors, Warren Buffet’s Berkshire Hathaway, over the last 5 years (an eternity for many clients) the S&P 500 has outperformed Berkshire Hathaway. However, over the past 20+ years, Berkshire has outperformed the S&P 500 by almost 3.5% per year, which equates to a share value more than two times the S&P 500. Patience, having faith in the process, strategic asset allocation coupled with tactical tilts in consideration of economic and market cycles is the value we strive to add as we interpret the enormous amount of daily economic and market data.”
Dave & Drew
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