Amid tariff wars, temporary truces, Brexit bewilderment and Hong Kong anti-government rallies, the global thermometer isn’t the only gauge that may leave you reeling between cooling chills and hot flashes this summer. Let’s take a refreshing journey back to May 2018, when Nobel Laureate and behavioral economist Daniel Kahneman presented how to improve our decision making process.
As Kahneman describes, “The problem is that humans are unreliable decision makers; their judgments are strongly influenced by irrelevant factors, such as their current mood, the time since their last meal, and the weather. … Whenever there is judgment there is noise and probably a lot more than we think.”
Let’s bring this back to investing. Does this mean everything you hear is noise, and nobody knows what’s going on? In terms of breaking news, it probably does. That’s why it’s all the more important to heed the tips Kahneman shared:
- Be disciplined. Kahneman refers to using algorithms, such as those used in Investing 3.0, for quieter, more consistent outcomes. Following such rules may not deliver as hoped for every time, but should outperform “judgments” (even from the “experts”).
- Think big-picture. Kahneman suggests: “See the decision as a member of a class of decisions that you’ll probably have to take over time.” This includes avoiding regret over past outcomes which is “probably the greatest enemy of good decision making in personal finance.”
- Be open to noise-dampening advice. Seek advice that helps you tune out rather than amplify judgmental noise. As Kahneman describes, a good advisor is a “person who likes you and doesn’t care about your feelings.”
Examples of noise-dampening advice can be found by describing the differences between what you read in the news, indexing, which is static, effectively frozen in time, changing little since 1972, and Investing 3.0, which targets other factors and continues to evolve.
On another note, in the attached Quarterly Market Review, you’ll see that the US stock market has continued its bull market run. Not only has it continued to outpace international markets, but, defying their historical averages, its large and growth stocks continued to beat small and value counterparts.
If you had used indexing to tilt your portfolio toward small and value stocks, you would have seen similar results. However, when employing Investing 3.0 we blend other factors, such as profitability in construction and momentum in trading, and mitigate the adverse performance of Q2’s size and value premiums.
I expect the value and the size premium to return because of their long-term historical performance and the economic rational supporting it. (In one recent test, we found that the short-fall in the value premium for US large stocks was the result of US large growth stocks having exceeded their long-term historical average by 67% for the last 10 years. I expect the value premium to return.)
One final note involves what I refer to as a difference in “construction.” Indexes include REITs and regulated utilities, sometimes among their largest holdings. In Investing 3.0, REITs are treated separately, in their own investment vehicle, and regulated utilities are excluded because even though their characteristics are similar to value stocks, they don’t perform as value stocks.
Okay, maybe I do care about your feelings a little bit. For example, if you’re feeling the heat from this summer’s unfolding news, I hope you’ll be in touch with your questions or concerns. If you know others who might benefit from this message, please share it with them and let them know that I’m available for a consultation.