Fix It Friday - The S&P 500, Performance Chasing and the Dangers of Outcome Bias

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whether you're just starting [: 00:00:30

And more to share fresh perspectives on making sound decisions that maximize your wealth. And now here's your host.

Hello, everybody. Welcome to [: 00:01:00

Uh, Performance chasing and what biases, uh, to avoid in order to succeed, uh, by avoiding performance chasing, which in my, uh, long history of, uh, [00:01:30] advising clients, uh, is one of the surest ways to underperform. So having said that, the reason I wanted to come with this topic today is because I've noticed a level of complacency.

that, that reminds me of the [: 00:01:45

So investors came up with a narrative to justify overbidding. Uh, at very high prices on Cisco systems, continued, uh, record growth as if it wouldn't continue from 2000 all the way for the next 20 years. [00:02:30] And instead what happened was in 2000, Cisco systems was valued at about 500 billion. Analysts of the day were predicting the valuation would hit a trillion.

reat company. It's valued at [: 00:02:45

When I was an [00:03:00] advisor, early in my career in 2000, uh, was, was very similar in a lot of ways. Investors had come off of a period of roughly five years from 1995, uh, 94 to 2000, where they made very, [00:03:15] very high double digit returns. Uh, a number of years where it was exce in excess of 20% a year, and it began to feel very easy.

their bets, their investment [: 00:03:30

So in other words, if you put 500 in an investment back then into the S and P 33 percent of the 500 or [00:04:00] roughly over 150 went into only 10 companies. It was very concentrated. The opposite of what we want to do when we invest for the long haul, which is to diversify our, our investments in great companies, uh, by virtue of owning stocks in them and.

In [: 00:04:15

The, the things they were selling [00:04:45] to be losers when in fact, the things they were selling, which were international companies, small company stocks, as opposed to the large company were actually simply just undervalued compared to the larger companies. They were cheap. Uh, and, and what they were doing is selling those [00:05:00] companies and using all the proceeds to pile on ever more to the companies that were selling at record high valuations and concentrating their bets.

at ended up happening is from: 2001

Uh, in, in those names I had mentioned, like Cisco systems and AOL and so forth. And those went down almost 70 percent for the decade, but to make matters worse, the second way they got hurt [00:05:45] is many of the things they sold to, uh, to, to, to change their mission from investing to speculating on a continued trend of those technology companies, continuing to grow.

verage, uh, which was really [: 00:06:00

Voiceover: what,

onathan Blau: what the third [: 00:06:15

It's too risky when in fact it was speculating that killed them, not investing. So we, when we have regret aversion bias, we go to what's called status quo bias, uh, in order [00:06:30] to avoid the pain of what we just, what happened to us regretting that, we just leave it in cash, status quo bias. So let me bring this all back to today, today, um, like 2000, the S& P 500 is very concentrated, but instead of [00:06:45] like in 2000 representing 33 percent in one sector.

goes all into technology. [: 00:07:00

They represent, those seven stocks, 33% [00:07:15] Of the value, uh, of, of the total, uh, index, which by the way, all of the companies in the S and P 500 today are worth 50 trillion. So seven companies account for, for over a 16 [00:07:30] heading to 20 trillion worth of the 50 trillion. It's much more concentrated than, than the market was back in 2000 when everything collapsed.

ention to history and to not [: 00:07:45

And for those who are retired and had to draw, let's say three or 4 percent on their portfolios, most of them never recovered from that. So when you're investing, you won't, you want to pay attention to [00:08:15] history. So how do, how do we, um, how do we deal with this? The other thing, by the way, is there was a study recently released by JP Morgan.

own as the price to earnings [: 00:08:30

Investors think that by piling on to the recent trend of what's doing really well, that they're increasing their [00:09:00] future return profile. All they're doing is increasing their future risk profile and doing it dramatically. They're exposing themselves to a potential lost decade kind of scenario. One of the things I noticed, and this is important for investors, [00:09:15] is when we diversify our portfolios during times like this, in order to justify making a concentrated bet, but still be able to say we are diversified, what we do is we, we create what's called, what I call a dino.

D I [: 00:09:30

So I have four different funds. All of which have the same top, uh, 33 percent of the money in the same seven companies. And I've seen this more and more because many [00:10:00] times advisors also will like to give the investor what they're looking for and what sounds good instead of what is good for them. So they'll say, Hey, look at these funds in their past three, four years.

P, uh, yet they all own the [: 00:10:15

So I say it's time to diversify. The way to diversify isn't to say, Hey, I've been selling a black umbrellas. I'm going to now sell yellow, green, orange, and red umbrellas. I'm diversified. No, I'm not. That's a dino kind of diversification. I've got [00:10:45] to buy a suntan lotion company so that when it stops raining, people buy suntan lotion.

e top portion of the S and P [: 00:11:00

Uh, so, so. What I would say is in some, uh, try to be aware of avoiding some [00:11:15] key biases. So there's something called the law of small numbers. When we look at a recent trend and reaching up to be five years, 10 years of returns, what we tend to do is extrapolate based on that trend. A future predictable, and that's the key word, [00:11:30] predictable trend, where none exists.

ter. So now everyone assumes [: 00:11:45

Eventually. It is something called mean reversion. His long term average will be reached because the next set of shots at some point will be missed and his average will reflect his long term average. That's called the hot [00:12:00] hand fallacy. Try to avoid that. Try to avoid making conclusions that are based on the law of ignoring the law of small numbers.

or tails, but that's. That's [: 00:12:15

It's not. The next coin flip has the same 50, 50 [00:12:30] odds. So we tend to, uh, to, to ignore the law of small numbers. You got to look at data over long periods of time. And, uh, and we saw in, in 2000 to 2010 is that the S and P failed for 10 years. If we factor [00:12:45] that into our, to our perspective today, we won't let what it did the last 10 years make us misbelieve that it's likely to outperform everything for the next 10.

Um, avoid confirmation bias [: 00:13:00

You're trying to confirm your recency bias that you think it's going to continue by only searching for why it's not risky, why it's likely to continue. Search for the opposite. Uh, that'll, that'll, that'll help you avoid becoming overconfident. Um, remember the game you're playing when, [00:13:30] when we're investing for retirement and to be able to retire comfortably and stay that way someday and leave money for our family, grow our portfolios.

compounding, it's all about [: 00:13:45

[00:14:00] Uh, that's compounding time is what does all the heavy lifting. One of the best kept secrets in investing is that, uh, finding, uh, kind of average investments and letting them return those average returns for long, long periods of time leads [00:14:15] to extraordinary results. I think Warren Buffett had said is made over, over, um, I think 90 percent of his money after the age of 65.

[: 00:14:30

There's a value style where companies are selling. Below their current, uh, their current valuation, that's fair. And those styles go in and out of favor at different times. Keep both of them always. Don't try to anticipate [00:15:00] based on, uh, guesswork when, when one might do better than the other, we don't know.

guiding principles that have [: 00:15:15

They come from buying things well. [00:15:30] And finally, there's no asset that's so good that it can't become so overpriced that it will become dangerous to your long term objectives. And there are few assets that are so bad that they can't get cheap enough [00:15:45] to be a bargain. Um, Last thought I want to leave you with, because this is, this is actually a powerful, um, a very powerful kind of, uh, emotional, uh, bias, I call it.

re's nothing more disturbing [: 00:16:00

I'm as smart as they are. And, and so watching friends get rich is, is damaging to our wellbeing, but also to our judgment. And that was said by a guy named McKay, who wrote the. [00:16:30] Pop, popular delusions and the, and the madness of crowds, uh, highlighting all of the, of the financial bubbles and, and, and impact, uh, going back to the, uh, the tulip bulbs in Holland and the 1600s.

So hopefully this podcast is [: 00:16:45

When we have outcome bias, we're not looking to the input. Is the input prudent? Am I well diversified? Is this really likely to continue for the next 10 years or has reversion to the [00:17:15] mean, the fact that things that have done well for the last five years are likely to underperform for the next five, going back to their mean or average?

about doing consistently the [: 00:17:30

[00:17:45] Remember you can access a crazy wealthy podcast and fix it Friday on our website, crazywealthypodcast. com. Uh, you can also access it on all your favorite podcast venues like Apple, Spotify, and, uh, and wherever you [00:18:00] generally get your podcast. Until next time, Jonathan Blau signing off.

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