Playing Dumb

Jonathan Clements

TO MANAGE OUR MONEY better, often we don’t need to know more. Instead, we need to unlearn what we think we already know.

Here are just some of the things that, at various points in my 35-year investing career, I’ve thought I’ve known:

  • Which fund managers will outperform.
  • Which way the economy is headed.
  • What’s next for interest rates and share prices.
  • Whether the overall stock market is overvalued or not.
  • Which individual stocks will beat the market.
  • Which stock market sectors and national stock markets will fare best.

Fortunately, this “knowledge” never greatly influenced my investment strategy. Still, I have little doubt that my portfolio’s performance would have been better if I hadn’t imagined that I knew these things—and I certainly wouldn’t have wasted so much time and mental energy.

Why do we think we know such things? It’s partly because Wall Street and the financial media talk endlessly about these issues. The financial media needs to fill airtime, websites and printed pages. Meanwhile, Wall Street wants to convince you that you know something about the future, so you actively manage your portfolio and thereby fatten the Street’s coffers.

But not all the blame belongs to others. Our belief that we have knowledge also partly stems from the way we’re wired. That wiring leaves us vulnerable to a host of behavioral mistakes, including extrapolation, overconfidence and recency bias, which together conspire to convince us that we know what the future will bring.

The problem: When we think we know something, we’re inclined to act upon that knowledge. In the financial markets, action almost always triggers investment costs and perhaps big tax bills. If we mess with our basic mix of stocks and conservative investments, we may miss a big market move—and any time we opt to reduce our overall stock exposure, we also lower our portfolio’s expected long-run return. And if our purported knowledge causes us to make narrow investment bets, we risk a permanent loss of capital, as we bet on stocks and market sectors that could potentially plunge—and never bounce back.

Even if we put our hands on our heart and we swear we aren’t inclined to forecast, predictions often creep into our behavior. We hold off investing because we sense share prices could fall. We tilt toward U.S. stocks because we think that they’ll always outperform foreign markets. Instead of prudently diversifying, we hang on to the employer shares we’re granted, because we can see that the company is prospering and we believe the stock price doesn’t fully reflect that.

What if we thought harder about such issues? No matter how much we analyze individual stocks, different market sectors and the overall market, there’s no evidence we’ll come up with a better forecast. Instead, our best bet is to not forecast. We need to unknow these things that we think we know, and instead focus on facets of investing where we have some control and where we truly can add value. We’re talking here about the amount of portfolio risk we take, the investment costs we incur and the taxes we pay.

There are also other areas of our financial life where hard work and more thought can pay handsome dividends. We can substantially improve our financial life by figuring out which debts to pay off first, what sort of home it makes most sense to buy, when to claim Social Security, what insurance we need and what estate planning steps we ought to take. We can also improve our life by spending more thoughtfully and saving more diligently—and by putting in the hard work needed to change our own damaging financial behavior.

To be sure, none of this has the seductive pleasure of making forecasts and imagining we’ll be proven right. But over a lifetime of investing, that pleasure, alas, almost always carries a steep price tag—and that’s one thing we all need to know.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Small PleasuresBrain Candy and Think Like Eeyore.

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Ira Rosenberg
Ira Rosenberg
2 years ago

Thanks for sharing this perspective. I think that, in my case, having an engineering background and some self-doubt in addition to having almost zero trust in salespeople that are not able to backup their proposal with data, I have done an excellent job staying in my lane. I did experiment with a small amount of individual stocks and even dabbled in commodity trading many years ago. It didn’t go well in either case and I regret doing so but in order to deal with the emotions of loss I considered it an educational expense and never did anything similar again. I have enjoyed very good results and success in my 35+ years of investing and personal finance by following the general advice of many people similar to and including you, Jonathan.

2 years ago

Another great read, but I smile reading this because recently I experienced intimately the psychic and statistically irrational pull to “chase the hot money” with regards to some current tech darlings. Truth is, the fable of the tortoise and the hare is enduring for a reason; it’s true. Betting on America, or more specifically big business America, has been a winning bet in the long run for essentially all investors roughly older than 40, if they started investing in a diversified portfolio entering the workforce at ~ 21 years of age. For me, a fair bit older even, it’s been even better, certainly better than any sector otherwise. So did I miss on Google and Tesla? Yup. But objectively, I’ve won in aggregate a whole lot more than I’ve lost. But when I see Amazon’s current share price am I similarly tempted? You bet. Hence the value of this article. It’s so easy to think the grass is greener next door, forgetting that your own grass has been green for so long you’ve taken it for granted.

Jay Rigler
Jay Rigler
2 years ago

I love this article. I found myself physically nodding my head in agreement the whole time I was reading it! I’ve done the same exact thing, thinking I knew more than the market. But, the reality is that the less I try to predict, the more I manage the things I can control (diversification, rebalancing) and the better my portfolio performs.

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