The results concluded that an astounding 32% of the participants went along with the group and shared the wrong answer. In the group where there was no pressure, less than 1% of participants shared a wrong answer. In the investment world, peer pressure can come in many forms (media, colleagues, family, water cooler, etc.) and ultimately, can make you less confident in your long-term plan.
Recently, investors have not exactly flocked to asset classes exhibiting cheaper valuations such as emerging markets over their U.S. large cap counterpart. While a “buy low, sell high” mentality would be a sign for investors to consider diversifying into international assets, for many people, it’s more comfortable to stick with buying the S&P 500. Overcoming the recent bias of experiencing 5 years of consecutive positive returns can be challenging for some but the sentiment to react can be just underneath the surface.
We’re Predictably Irrational
Dan Ariely, Behavioral Economist from MIT, led a fascinating talk3 on how our intuition often fools us in repeatable, predictable and consistent ways. For many, selling out of a beloved stock may invoke strong emotions. When a favorite stock rises, there’s a tendency to hold on in order to avoid selling too soon. Conversely, if the same stock falls, investors tend to sympathize with the predicament and hold on to let the stock try and bounce back to avoid realizing a painful loss. This behavior reflects the influence our emotional state has over decisions which may not make sense from an investment perspective. In the absence of a thoughtful strategy, how we feel at the time paradoxically becomes the underlying strategy to our investment detriment.
The Paradox of Choice
Social theory pioneer, Barry Schwartz, challenges the notion that more choice and more freedom is better4. He quips on the experience of selecting a salad dressing out of the 175 choices available at the grocery store or setting up a stereo system where there are 6.5 million stereo system combinations at the electronic store. The same could be said about diversification, where investors are lead to believe that the more investments and more holdings in a portfolio, the better for performance and risk. Using too many managers within an asset class can essentially translate to owning an entire universe of stocks while paying higher costs over a conventional basket of stocks within an index. Anecdotally, you could envision such managers holding opposing viewpoints within their respective portfolio, thus limiting or cancelling the potential benefit of one manager over another. In looking at the numbers, survivorship and long-term outperformance across managers are potential issues. In a study conducted by Vanguard on 1,540 actively managed U.S. equity funds, only 55% survived over a 15-year period and of those that survived, only 18% had outperformed.
