Last week, in the New York Times Gary Belsky wrote an article titled “Why We Think We’re Better Investors Than We Are.” In it, he lists several common cognitive biases which lead people to make poor investment decisions.
However, I suspect (due to the first bias Belsky lists—overconfidence) a lot of individuals who read this article are going to think, “Sure, this stuff is true for most people—but, not me. I’m different.” Belsky puts it like this:
“Ask a random player in a law firm’s basketball league whether he or she could compete with LeBron James, and the most common response will be laughter. Yet many of those lawyers would willingly compete with the billionaire investor Warren E. Buffett.”
The Mistakes We Make
I recently stumbled across an interesting tool called Openfolio. Billed as a way for investors to share ideas, what it actually does is quantify their results and reveal the mistakes made. The site aggregates data across users and highlights a few very basic and fundamental mistakes that investors continue to make. (See their full report here.)
Mistake #1 – Investors consistently take on too much risk.
According to Openfolio, 24% of their users lost money in 2014, a year in which the S&P 500 index was up nearly 14%. And the investors that lost money had an average volatility that was 85% higher than the investors who made money in 2014 (31.8% annualized volatility compared to 17.2% for those who made money).
Mistake #2 – Picking individuals stocks.
Again, the 24% of investors who lost money in 2014, on average had 71% of their portfolios invested in individual stocks. Those who made money in 2014, had considerably less—although a still too high 53% of their portfolios—invested in individual stocks.
Mistake #3 – Investors have too much of their portfolios sitting in cash.
Investors who lost money in 2014 had 64% more cash in their portfolios than those who made money (18% cash compared to 11%). Cash might be helpful in a downturn, but with the market producing positive returns in nearly three-quarters of all years, it’s best not to try and time the market.
The potentially good news (depending on your age and gender) from the data is that people get better at investing as they age and women fared better than men. See the graphic below for all the results.
Being Okay with “Simple and Dumb”
When talking with clients or prospects, we often stress the importance of getting these fundamentals right—setting the right level of risk, diversifying, and not timing the market—in addition to the basics of making a financial plan, reducing expenses, minimizing taxes, setting a target allocation and sticking with an investment strategy.
But, often the value of these fundamentals get discounted. At Cordant, we work with current and former Intel employees—a bright bunch no doubt. Often the thought is that there’s got to be more to it than this, and, of course, there is. But, getting the fundamentals down is a critical place to start.
In the early 80’s, Intel struggled with low yield rates and the problem took on vital importance given the dual threats of recession and competition from Japanese manufacturers. Future Intel CEO Craig Barrett came up with a solution to increase yields called Copy Exactly—the precise “matching [of] the manufacturing site to the development site.” Barrett, according to Michael Malone in his book The Intel Trinity, got the idea from McDonald’s. Barrett said:
“I asked myself why McDonald’s French fries tasted the same wherever I went. That’s what I told my guys, ‘We’re going to be the McDonald’s of semiconductors.”
As you can imagine, this didn’t go over very well at first. People reject this notion as “simple and dumb”. It may work with French fries but not semiconductors. Barrett had to overrule his managers in a “contentious meeting” just to put the plan into place.
But it worked. In just a few years yield rates rose to 80 percent and equipment utilization improved from 20 percent to an amazing 60 percent. Malone sums it up like this:
“Intel had to learn to be dumb and simple—the most difficult things imaginable to a company named after intelligence and building the most complicated devices in the world. It was a crucial lesson.”
Manufacturing computer chips is infinitely more complicated and precise than making French fries. However, if a simple and dumb approach can work for Intel, it can work for your investment portfolio too.
Get the fundamentals down, reduce your mistakes, and you’ll have already gone a long way towards being a successful investor.
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Cordant, Inc. is not affiliated or associated with, or endorsed by, Intel.