The post was originally published here.
Listen on
Apple | Google | Stitcher | Spotify | YouTube | Other
Q1 2023 hedge fund letters, conferences and more
Quick take
In this episode of Investment Strategy Made Simple (ISMS), Andrew and Larry discuss two chapters of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this third episode, they talk about mistake number three: Do you believe events are more predictable after the fact than before? And mistake number four: Do you extrapolate from small samples and trust your intuition?
LEARNING: Know your investment history. Don’t be subject to confirmation or recency biases.
“The key to long-term success is having a deep understanding of history and not being subject to recency bias.”
Larry Swedroe
In today’s episode, Andrew continues his discussion with Larry Swedroe, 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 a chapter of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this third series, they talk about mistake number three: do you believe events are more predictable after the fact than before? And mistake number four: do you extrapolate from small samples and trust your intuition?
Missed out on previous mistakes? Check them out:
- ISMS 8: Investment Mistake No.1: Are You Overconfident in Your Skills?
- ISMS 17: Investment Mistake No.2: Do You Project Recent Trends Indefinitely Into the Future?
Mistake Number 3: Do you believe events are more predictable after the fact than before?
People often believe that events are more predictable before the fact than after. Larry says this is a big investment problem because it leads to overconfidence. After all, investors think they know what the outcome is.
To avoid making this mistake, Larry’s advice is not to act immediately because if you do, you’re likely acting based on irrational fears. You don’t know the investment history and have a confirmation bias. The cure for this bias of believing events are inevitable is to think before the fact when the events are far from certain, let alone inevitable.
Before you invest, Larry says you should keep a diary. Write down what you think will happen and compare it with the results after the fact. This analysis shows that you don’t know the future any better than anyone else. Your crystal ball is just as blurry. So don’t try to make forecasts based on your views because you think events are predictable.
Mistake Number 4: Do you extrapolate from small samples and trust your intuition?
People make investment judgments based on small samples, typically recent ones. For example, growth dramatically outperformed small-value stocks in 1997, 98, and 99 because of the Dotcom bubble.
So people judging by that small sample didn’t look at the long-term historical evidence, showing a 20% chance that growth will outperform small value over any three-year period. At five years, the likelihood drops to 15%. At 20 years, the chances of this happening are between 3% and zero. So there’s always a chance that growth will outperform small value, but the longer the period, the less likely it will happen.
Larry insists that you have to know your investment history. Whenever you see a small sample, look at the long-term data and remember that when investing in risk assets, three years is a very short time, and five years is still a pretty short time. You need much longer periods. The key to successful investing is not intelligence; it’s patience.
Final thoughts from Larry
Know your investment history and keep that diary every time you make a forecast.
Article by Andrew Stotz, Become a Better Investor.
