ISMS 20: Larry Swedroe – Do You Extrapolate From Small Samples and Trust Your Intuition?

Apr 20, 2023

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In this episode of Investment Strategy Made Simple (ISMS), Andrew and Larry discuss a chapter 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 subjected to confirmation or recency biases.

“The key to long-term success is having a deep understanding of history and not being subjected 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:

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.

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.

ISMS 20: Larry Swedroe – Do You Extrapolate From Small Samples and Trust Your Intuition?

Mistake Number 3: Do you believe events are more predictable after the fact than before?

Mistake Number 4: Do you extrapolate from small samples and trust your intuition?

Final thoughts from Larry

About Larry Swedroe

Connect with Larry Swedroe

Andrew’s books

Andrew’s online programs

Connect with Andrew Stotz:

Further reading mentioned