Imagine Crossing the Behavior Gap

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  • on September 17th, 2010

As written before, I am an active manager of portfolios.  It’s partly to aim for higher returns, but mostly to manage risk.  Yes, I believe keeping costs low is Rule #1 of performance, but it’s not the only rule.  One could have kept costs low in the past decade and failed to keep up with inflation.  Diversify into fixed income?  Sure, but that wouldn’t have done much for you in the 70s, right?

Passive investment is the best approach for many, but only if the investor’s imagination is focused on some life 30 years out and not on the market conditions over the next year.  Exposed to the possibility of selling at the worst possible time, it’s a biological fact that most of us will.  Not only that, historical returns of passive investing have no bearing on future returns.  If anything, a truly conservative planner would exclude returns from 1945-2000…seriously, what do we expect the U.S to do for an encore?

I won’t force a Lennon metaphor into this post.  I simply want to discuss the other side of the behavior gap so elegantly displayed by Carl Richards.  Where I think investors as a whole fail is in a lack of imagination.  There are constant opportunities to exploit, and those with a robust action plan do it regularly.

A review of Dalbar studies shows investors earning 3% over a period in which the average fund returned 8%…where did the money go?  Let’s say we attribute 1% to management fees, and another 1% to transaction fees…was the other 3% flushed down the drain?  No, it went to the alpha generators, fewer in number but the other barbell on the return scale…hundreds of billions transferred from weak hands to strong.

We just saw money flow out of domestic funds for 19 straight weeks…who is selling?  Those who can’t imagine an improving economy, or better investor sentiment, or new and exciting innovations.  Certainly there are hardship cases forcing people to cash in stocks to pay expenses, but with prices the same that tells us someone has accepted the risk that the sellers can no longer take.

I love this post from one of my new favorite bloggers, Michael Bigger.  It is a messy stream of consciousness expression of 42 ideas that came to his head for improved performance, and there are some gems.  The real gem is taking the time to tap into our creative side, jot down some thoughts, and work on ways to execute an idea or two.

Mainstream news exposes us to stale thinking from bank CEOs and government officials, who seek only to keep up with their competition and save face.  But what about the radicals?  We’ve seen genius in front of us with CEOs like Steve Jobs, Steve Wynn, and Jeff Bezos…real visionaries who scoffed at naysayers and built products consumers have come to LOVE, even if we didn’t know we needed them.

John Templeton, there’s a guy with an imagination.  In the midst of World War II, he took his savings and bought every $100 of every stock under $1.  Many were duds, but the few that worked out launched him to become one of the world’s wealthiest men.  John W. Henry imagined that if he studied commodity prices he could earn a living trading them…he became one of the largest CTAs simply buying when prices rose and selling when they stopped rising.  Oh yeah, he bought the Boston Red Sox in time for them to become world champs.  Jim Simons thought he could apply his math knowledge into a trading strategy…he’s now worth $8 billion and one of the largest funders for autism research and math education.

Sorry for the Tony Robbins moment.  I’m simply saying that there is another side to the behavioral mistakes we as humans make…the profitable side.  The mistakes aren’t “once in a while” exceptions…they are the rule.  Those who either manage emotions(tough) or embrace planning for them(easier) create the opportunity to join the small but prosperous end of the behavior barbell.  I agree with the diagnosis of us as flawed beings, I just imagine a different prescription.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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