Enrich Your Future 33: The Market Doesn’t Care How Smart You Are

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 33: An Investor’s Worst Enemy.LEARNING: You are your own worst enemy when it comes to investing. “The right strategy is to avoid the loser’s game. Don’t try to pick individual stocks or time the market, just invest in a disciplined way, and you will win by getting the market’s return.”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 33: An Investor’s Worst Enemy.Chapter 33: An Investor’s Worst EnemyIn this chapter, Larry demonstrates why investors are their own worst enemies. He observes that many people think the key to investing is identifying the stocks that will outperform the market and avoiding the ones that will underperform.Yet the vast body of evidence says that’s playing the losers’ game. He adds that most professionals with advanced degrees in finance and mathematics, with access to the best databases and huge advantages over individuals, often think they’re smart enough to beat the market.They do so by attempting to uncover individual securities they believe the rest of the market has somehow mispriced (the price is too high or too low). They also try to time their investment decisions to buy when the market is “undervalued” and sell when it is “overvalued.”However, evidence shows that 98% of them fail to outperform in any statistically significant way on a risk-adjusted basis, even before taxes. As historian and author Peter Bernstein puts it: “The essence of investment theory is that being smart is not a sufficient condition for being rich.”Why do people keep playing the loser’s game?In the face of such overwhelming evidence, the puzzling question is why people keep trying to play a game they are likely to lose. From Larry’s perspective, there are four explanations:Because our education system has failed investors and Wall Street, and most financial media want to conceal the evidence, people are unaware of it.While the evidence suggests that playing the game of active management is the triumph of hope over wisdom and experience, hope does spring eternal—after all, a small minority succeed.Active management is exciting, while passive management is boring.Investors are overconfident—a normal human condition, not limited to investing. While each investor might admit that it’s hard to beat the market, each believes he will be one of the few who succeed.So, what is the right strategy?In light of the evidence presented, Larry’s advice is clear: avoid the losers’ game. Instead of trying to pick individual stocks or time the market, he advocates for a disciplined approach to investing. Investors can win by staying the course through bear markets by simply getting the market’s returns. This, he argues, is the right strategy for successful investing.Suppose you choose to play the game of active investing. In that case, Larry warns, the only ones likely to benefit are your financial advisor, broker-dealer, the manager of the actively managed fund, and the publisher of the newsletter or ratings service you subscribe to. The odds are overwhelmingly against individual investors in this game, making it a futile endeavor.Further readingJonathan Fuerbringer, “Investing It,” New York Times, March 30, 1997.Robert McGough, “The Secret (Active) Dreams of an Indexer,” Wall Street Journal, February 25, 1997.Peter Bernstein, The Portable MBA in Investment (Wiley, 1995).Jonathan Clements, 25 Myths You’ve Got to Avoid (Simon & Schuster, 1998).James H. Smalhout, “Too Close to Your Money?” Bloomberg Personal (November 1997).Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes (Simon & Schuster, 1999).Peter L. Bernstein and Aswath Damodaran (editors), Investment Management (Wiley, 1998).Ron Ross, The Unbeatable Market (Optimum Press, 2002).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 OutperformEnrich Your Future 01: The Determinants of the Risk and Return of Stocks and BondsEnrich Your Future 02: How Markets Set PricesEnrich Your Future 03: Persistence of Performance: Athletes Versus Investment ManagersEnrich Your Future 04: Why Is Persistent Outperformance So Hard to Find?Enrich Your Future 05: Great Companies Do Not Make High-Return InvestmentsEnrich Your Future 06: Market Efficiency and the Case of Pete RoseEnrich Your Future 07: The Value of Security AnalysisEnrich Your Future 08: High Economic Growth Doesn’t Always Mean High Stock Market ReturnEnrich Your Future 09: The Fed Model and the Money IllusionPart II: Strategic Portfolio DecisionsEnrich Your Future 10: You Won’t Beat the Market Even the Best Funds Don’tEnrich Your Future 11: Long-Term Outperformance Is Not Always Evidence of SkillEnrich Your Future 12: When Confronted With a Loser’s Game Do Not PlayEnrich Your Future 13: Past Performance Is Not a Predictor of Future PerformanceEnrich Your Future 14: Stocks Are Risky No Matter How Long the HorizonEnrich Your Future 15: Individual Stocks Are Riskier Than You BelieveEnrich Your Future 16: The Estimated Return