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BARRY RITHOLTZ’S NEW BOOK, How Not to Invest, offers investors a cautionary tale—many of them, in fact.
Ritholtz has been in and around the investment industry for more than 30 years—as a trader, a journalist and, most recently, as cofounder of a wealth management firm.
In short, he is no stranger to Wall Street. His conclusion? It can be a minefield.
Bad actors like Charles Ponzi and Bernie Madoff are well known. The reality, though, is that they represent just one of the many types of financial risk we might encounter. To help investors navigate the “bad ideas, bad numbers and bad behavior” that pervade the world of investing, How Not to Invest represents a field guide of sorts.
These are four of the most common pitfalls Ritholtz identifies:
The Media
Research dating back to the 1980s has shown that financial news can be detrimental to investors. Counterintuitively, when investors have access to more information, they tend to make worse decisions. Why? In large part, it’s because people—understandably—feel that they need to take action when they receive new information. So they’ll tend to place trades in response to new news. But since no one has a crystal ball, this increased trading tends to be counterproductive.
This phenomenon has been documented for years. But because of the increased number of news outlets, Ritholtz argues that this problem has only gotten worse.
Among the ways that news can lead investors astray: “denominator blindness.” In presenting financial news, commentators often present numbers out of context, with the result that the news ends up seeming more dramatic and worse than it really is.
As an example, How Not to Invest cites a news item about Amazon laying off 18,000 workers a few years back. That number sounds big, but it leaves out the denominator, which would provide context: Since Amazon employs about 1.5 million people, a layoff of 18,000 people would translate to just 1% of its workforce. As a result, it isn’t a meaningful commentary on the health of the company.
Similarly, the media often exaggerate stock market news. Back in 1987, when the market fell 508 points in one day, it was an unprecedented event, translating to a 22% decline. But today, with the Dow close to 47,000, a 508 point drop would translate to an almost insignificant loss of just 1.1%.
The lesson: It’s okay to follow the news, but we need to recognize that writers—especially headline writers—tend to have a bias. To grab readers’ attention, they need to make statements that sound like big news. So always ask, what’s the denominator?
Ritholtz puts Wall Street strategists in the same category as attention-seeking financial journalists. “I have met many of these people,” he writes. “Their general advice is for entertainment purposes only. Their forecasts are nothing more than marketing.”
Psychology
Seventy-five years ago, Benjamin Graham noted the importance of investor psychology: “The investor’s chief problem—and even his worst enemy—is likely to be himself.” Ritholtz argues that this also may be a bigger issue today than it was in the past. As sophisticated and as logical as we may try to be, ultimately, “we are social primates,” he says. That makes it very hard to ignore what everybody else is doing, especially when the crowd appears to be going in a different direction.
Clifford Asness, a hedge fund manager and author, has commented on this phenomenon. He argues that social media has made the market less efficient in recent years. The meme stock craze of 2021, for example, was driven by a YouTuber in his basement. He and his followers help to push up the prices of certain stocks. That, in turn, made it harder for observers to stay on the sidelines. That drew in new investors who, in turn, pushed prices up further.
That kind of thing couldn’t have happened as easily in the past. But today it’s another pitfall for investors to guard against.
Opinion
How can we combat the twin effects of media bias and investor psychology? Ritholtz notes that we all tend to live in “belief bubbles” with others who share our views—yet another effect of social media. To break out from these silos, we need to actively seek out opposing points of view. Just as Charlie Munger would urge investors to “invert” a hypothesis to pressure-test it, Ritholtz suggests that we intentionally follow commentators we disagree with.
I do this myself. Among those I follow is Michael Burry, an investment manager and protagonist of the book The Big Short. He’s an advocate of active management and has issued dire forecasts about index funds. While I disagree, I listen carefully to his arguments. I also follow the proponents of bitcoin, of modern monetary policy and of various other ideas I disagree with.
Data
A key challenge in the investment world is that the data can sometimes be misleading as well. Consider market valuation metrics. For years, investors have fretted that the market is expensive, Ritholtz notes, and yet, it’s continued to rise nearly every year since 2009. “Bull markets tend to go longer and further than anyone expects,” he’s noted. As a result, metrics like price-to-earnings ratios aren’t terribly useful.
“If you only buy stocks when they’re cheap,” Ritholtz says, “you get these narrow windows every decade or so.” The solution? Investors should simply dollar-cost average over time and take the long view.
To be sure, there are a lot of potential potholes on the investment landscape. The good news, though, is that Ritholtz also includes a prescription for how investors should invest, and it isn’t complicated. It’s telling, in fact, that this is the shortest section of the book. As Charley Ellis first pointed out 40 years ago in Winning the Loser’s Game, investors don’t need to do anything sophisticated to succeed. We don’t need to find the next Apple or Nvidia. Instead, the most important thing is to simply avoid making mistakes. Avoid the potholes, and the path to success is surprisingly simple.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
“Amazon laying off 18,000 workers”
Dismissing this as trivia is really callous. For those 18,000 it could be absolutely catastrophic.
Especially when the CEO makes untold billions.
Great article, and a fun read. Buffett directed me a long time ago, and I buy no more individual stocks. I am at 63% S&P 500, and with ETF QQQ and BRK-b at 80% of my portfolio. I rely on Cash to tide me over when the market takes a dive, as I got rid of bonds 15 years ago. At 80 years old, this works for me. Adam keep writing those great articles, and thanks.
I also listened to his interview on Morningstar’s podcast The Longview. It was excellent. Give it a listen if you have some time.
What made me a humble index investor? I considered myself an expert in one industry, telecommunications, a few decades ago. That was where my job was, and I had lots of exposure to the public companies in that area, and to their top executives. I thought I knew the opportunities and the dangers, and which companies would prosper. But try as I might, my mistakes still outweighed my successes. If I couldn’t do well with stocks in an area I knew, I sure wasn’t going to be a good stock picker anywhere else. Thank God for indexes.
“If you only buy stocks when they’re cheap,” Ritholtz says, “you get these narrow windows every decade or so.” The solution? Investors should simply dollar-cost average over time and take the long view.
There’s nothing wrong with only buying every decade or so. You just have to know what price you are willing to pay, and be sure to buy when the stock hits your target.
“Investors need patience, cash, and courage, in that order.”
-William Bernstein
My favorite investing book: “Winning the Loser’s Game”, because it uses tennis as an analogy. Most points in tennis are lost, not won; the way to win is to avoid unforced errors. This book solidified my conviction that buying index funds, for me, was the simplest, most error-free method to become wealthy.
In his career Roger Federer won 54% of the points he played (or lost 46%) but won 80% of his matches. He mastered the art of not making mistakes at critical times.
Thanks for the great article. Ritholz has a podcast called, “Masters of Business” in which he does a good job interviewing his guests. I really don’t listen to any opinions on an investment anymore unless the person opining has skin in the game. If they have their own money up, I can at least consider what they have to say. Otherwise, it means nothing to me. CNBC has to fill huge amounts of time and thus much of what is said on there has no real meaning or relevance.
It is sometimes difficult to resist taking action in response to financial news in the media, but then I remember Charlie Munger, who said “don’t do anything stupid”. And I remind myself that the whole point of diversification, asset allocation and rebalancing is to protect my portfolio from whatever future surprises may be in store. So, I don’t need to respond to the latest “breaking news”; in fact I can ignore it! As Danny Kahneman wrote, our quick responding “system I thinking” served us well in prehistoric times, when quick, reflex responses were vital in order to survive. When making decisions about complex matters today however, our slower, more deliberative “system II thinking” protects us from taking impulsive, emotionally driven actions. Very good article with useful reminders for us all.
Thanks for pointing us toward Ritholtz’s book. And for the link to the site with mental models.
It’s tough to break out of our “belief bubbles”.
“It’s okay to follow the news, but we need to recognize that writers—especially headline writers—tend to have a bias. To grab readers’ attention, they need to make statements that sound like big news. So always ask, what’s the denominator?”
I don’t much watch the evening news anymore, mostly because of this reason. Whenever there is a “storm” in the east US, where I am, inevitably the commentator will start the news with something like “Breaking news, monster storm in the northeast US, 100 million people at risk”.
I am one of those people – I end up getting 7 drops of rain and a breeze that wouldn’t stop a mosquito. Hmmmm… Kind of dulls the senses after a while.
Great piece—it really drives home how most investing mistakes come from reaction, not strategy. The reminder to filter media noise, stay grounded psychologically, and just keep dollar-cost averaging is simple but powerful. Most investors would do far better by focusing on not doing the wrong things than chasing the next big win.
I think I heard the term “no noting investor” from Buffet. I also call it Mr. Magoo investing. Catastrophes abound around him but Mr. Magoo just keeps going through them, Maybe sometimes ignorance can be bliss.
Great article, thanks. I think the most important passage is “The solution? Investors should simply dollar-cost average over time and take the long view.”
If everyone just dollar cost averaged into broadly diversified index funds and left them there for decades, the overall result would be very good.