ISMS 27: Larry Swedroe – Familiar Doesn’t Make It Safe and You’re Not Playing With the House’s Money
My Worst Investment Ever Podcast
The Importance of Understanding the Distribution of Potential Terminal Outcomes
People become over confident in the sense that they treat the highly unlikely as if it's impossible when you look at that 10 million distribution and there's a 10% chance you'll end up with two. You have to seriously consider what would i do if it ended up at two am i willing to work a lot longer live on that only two million portfolio is that an acceptable outcome? I'm sure nobody in japan in 1990 after years of spectacular double-digit returns forYou know the prior 20 years had anything more than 1%. The next 33 years the japanese nike index returned 0.2 percent a year worse than inflation so you know those things can happen the u.s could
In this episode of Investment Strategy Made Simple (ISMS), Andrew and Larry discuss three chapters of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this eighth episode, they discuss mistake number 13: Do you confuse the familiar with the safe? Mistake number 14: Do you believe you’re playing with the house’s money? And mistake number 15: Do you let friendship influence your choice of investment advisors?
LEARNING: Just because you’re familiar with something doesn’t make it less risky. Diversify globally to get the real benefits of diversification. Your financial advisor is not your friend; it’s a business. Value and protect your investment gains as much as you value and protect the principle.
“We’re all human beings and have made these mistakes. What differentiates smart people from others is that they don’t repeat the same behavior when they learn it’s a mistake. They change it. They become aware of investment biases and overcome them either on their own or with the help of a trusted financial advisor.”
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 eighth episode, they discuss mistake number 13: Do you confuse the familiar with the safe? Mistake number 14: Do you believe you’re playing with the house’s money? And mistake number 15: Do you let friendship influence your choice of investment advisors?
Missed out on previous mistakes? Check them out:
- ISMS 8: Larry Swedroe – Are You Overconfident in Your Skills?
- ISMS 17: Larry Swedroe – Do You Project Recent Trends Indefinitely Into the Future?
- ISMS 20: Larry Swedroe – Do You Extrapolate From Small Samples and Trust Your Intuition?
- ISMS 23: Larry Swedroe – Do You Allow Yourself to Be Influenced by Your Ego and Herd Mentality?
- ISMS 24: Larry Swedroe – Confusing Skill and Luck Can Stop You From Investing Wisely
- ISMS 25: Larry Swedroe – Admit Your Mistakes and Don’t Listen to Fake Experts
- ISMS 26: Larry Swedroe – Are You Subject to the Endowment Effect or the Hot Streak Fallacy?
Mistake number 13: Do you confuse the familiar with the safe?
People tend to double up on investments they’re familiar with compared to new companies. But according to Larry, knowing about something doesn’t make it safer. When it comes to risk, people think of something they’re familiar with as safer. When they’re less familiar with it, it becomes more uncertain.
People over-allocate to their domestic stock market and underweight international stocks. This bias causes investors to be overconfident and take too much risk by concentrating on assets they’re most familiar with.
To avoid this bias, the guiding principle is that just because you’re familiar with something doesn’t make it less risky. Diversify globally to get the real benefits of diversification.
Mistake number 14: Do you believe you’re playing with the house’s money?
To explain this mistake, Larry uses the story of the man in the green bathrobe. In the story, a newlywed couple goes to Las Vegas on their honeymoon. Being intelligent, they set aside $1,000 as their gambling money for their week in Las Vegas.
Unfortunately, by the end of the second night, they’d blown the entire $1,000. At the end of that night, the husband was getting ready to go to bed when he saw a little shiny object on the dresser. He picked it up, and it was a $5 chip. The man saw this as a sign to go to a roulette wheel and use that chip. So he quietly left the room and took a cab to the nearest local casino.
The man put the $5 chip on the number 17 because that was the number on the chip. At 35 to-one odds, he won. He played again and won. The man won about five times and now had $6.1 million.
A huge crowd had gathered around the table to watch the man play again. The roulette dealer spun the wheel, and it looked like it would drop on 17. Then it fell over the next number. The man lost all his winnings. Because he was in such a hurry when he left his room, the man was still wearing the hotel’s green bathrobe—in which he had to walk back to his hotel and explain to his wife what’s happened. He tried to sneak in, but his wife was awake. He told her that he’d gone to the casino. She asked how it went, and he said he’d lost five bucks.
The man’s problem was thinking that he didn’t lose $6 million because it wasn’t his money but the house’s money. Now, if someone had given him a check for $6 million, there’s no way he would have bet it on the roulette wheel.
When it comes to investing, Larry says that most people are lucky to find stock at low prices. But when the stocks become winners, they don’t see the gains made as their money. So majority never feel the need to protect their profits and end up losing them.
Mistake number 15: Do you let friendship influence your choice of investment advisors?
Many investors will often hire financial advisors who are their friends. Their decision is not based on facts but on emotion. They’ll continue depending on the financial advisor even when their investments perform poorly. They won’t fire them because they’re friends. The truth is that they’re only your friend because they’re making commissions or other fees off of you. Friendships have caused people so much of their fortunes unnecessarily.
About Larry Swedroe
Larry Swedroe is head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.
Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.
Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.
Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.
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Connect with Larry Swedroe
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Further reading mentioned
- Larry Swedroe and RC Balaban, Investment Mistakes Even Smart Investors Make and How to Avoid Them
- Philip E. Tetlock, Expert Political Judgment: How Good Is It? How Can We Know?
- Carol Tavris and Elliot Aronson, Mistakes Were Made (But Not by Me): Third Edition: Why We Justify Foolish Beliefs, Bad Decisions, and Hurtful Acts
- Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the Life-Changing Science of Behavioral Economics
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