My Worst Investment Ever Podcast

Enrich Your Future 28 & 29: How to Outsmart Your Investing Biases

Apr 7, 2025

13:27

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 28: Buy, Hold, or Sell and the Endowment Effect and Chapter 29: The Drivers of Investor Behavior.

LEARNING: Smart people are humble and able to admit when they have made a mistake.

“As humans, we make all kinds of behavioral errors. Thus, it should not be surprising that we make them when investing. Smart people are, however, humble and able to admit when they have made a mistake.”

Larry Swedroe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. 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 Chapter 28: Buy, Hold, or Sell and the Endowment Effect and Chapter 29: The Drivers of Investor Behavior.

Chapter 28: Buy, Hold, or Sell and the Endowment Effect

In this chapter, Larry discusses one of the more frequent risk management problems: holding or selling an asset and how the endowment effect affects this decision.

The endowment effect

Larry begins by empathetically explaining how the endowment effect, a common behavioral quirk, often causes individuals to make poor investment decisions. For example, it leads investors to hold onto assets they wouldn’t purchase if they didn’t already own them. Whether it’s because the assets don’t fit into their asset allocation plan or because they view them as overpriced, they’re no longer the best choice from a risk/reward perspective.

Larry shares the most common example of the endowment effect. People are often reluctant to sell stocks or mutual funds that they inherited or a deceased spouse purchased. Many people will usually say, “I can’t sell that stock; it was my grandfather’s favorite, and he’d owned it since 1952.” Or, “That stock has been in my family for generations.” Or, “My husband worked for that company for 40 years. I couldn’t possibly sell it.”

Another example of an investor subject to the endowment effect is stock accumulated through stock options or some type of profit-sharing/retirement plan.

How to avoid the endowment effect

Larry says you can avoid the endowment effect by asking: If I didn’t already own this asset, how much would I buy today as part of my overall investment plan? If the answer is, “I wouldn’t buy any,” or, “I would buy less than I currently hold,” you should sell. The rule applies whether the asset is a bottle of wine, a stock, a bond, or a mutual fund.

He adds that you should only own an investment if it fits into your overall asset allocation plan.

Chapter 29: The Drivers of Investor Behavior

In this chapter, Larry discusses how investors make errors simply because they are humans prone to behavioral mistakes. He reviews some of the more common ones to help you avoid making such mistakes.

Ego-driven investments

In this type of mistake, investors want more than returns from their investments.

For instance, some investors continue investing in hedge funds, despite their lousy performance, for the same reasons they buy a Rolex or carry a Gucci bag with an oversized logo—they are expressions of status, available only to the wealthy.

Such investment decisions are ego-driven, with demand fueled by the desire to be a “member of the club.”

The desire to be above-average

Overconfidence in our abilities is a very healthy attribute. It makes us feel good about ourselves, creating a positive framework for navigating life’s experiences. Unfortunately, being overconfident in our investment skills can lead to investment mistakes—and so does what seems to be the all-too-human desire to be above average.

Overconfidence is such a huge problem that it even causes people to delude themselves—the truth is so painful that the delusion allows them to continue to be overconfident. It leads to unrealistic optimism, causing investors to concentrate their portfolios on a handful of stocks rather than gain the benefits of diversification (the only free lunch in investing).

Framing the problem

According to Larry, many errors we make as human beings and investors result from how we frame problems. “Framing the problem” refers to the way we perceive and interpret a situation, which can significantly influence our decisions. If a situation is framed from a negative viewpoint, people tend to focus on that. On the other hand, if a problem is framed positively, the results are pretty different. Consider the following example from Jason Zweig’s Your Money & Your Brain:

Pregnant women are more willing to agree to amniocentesis if told they face a 20% chance of having a Down syndrome child than if told there is an 80% chance they will have a normal baby.

Regarding investing, the so-called professionals are framed as having all the advantages. The average investor then believes they stand no chance against the “professionals” and invests in active funds.

However, Larry quotes various investment gurus and researchers who believe that investors without knowledge of the stocks they buy can earn market returns by investing in index funds. Since the average fund underperforms its benchmark index fund, and the average active investor underperforms the very funds in which they invest, the know-nothing index investor earns above-average returns by simply earning market returns.

Confirmation bias

Another major cause of investment errors is “confirmation bias,” the tendency for people to favor information that confirms their preconceptions or hypotheses regardless of whether the information is true while disregarding evidence that is contrary to them. As a result, people gather evidence, recall information selectively from memory, and interpret it in a biased way.

For instance, investors who believe they can pick winning stocks are regularly oblivious to their losing record and record wins as evidence confirming their stock-picking skills. However, they neglect to record losses as disconfirming evidence. Similarly, investors may ignore negative news about a company they are invested in, focusing only on positive information that supports their investment decision.

Be humble and admit your mistakes

In conclusion, Larry reiterates that we’re all human and prone to behavioral mistakes. However, he underscores the importance of humility in admitting when we’ve made a mistake. He encourages us to see learning from our errors as a cause for celebration, as it means we’ll be less wrong in the future. He reminds us that what sets us apart from fools is our ability to learn and not repeat our mistakes, expecting different outcomes.

Did you miss out on the previous chapters? Check them out:

Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to Outperform

Part II: Strategic Portfolio Decisions

Part III: Behavioral Finance: We Have Met the Enemy and He Is Us

About Larry Swedroe

Larry Swedroe was 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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