FREE NEWSLETTER

Anxiety, Personality and the Active vs. Passive Fund Decision by Steve Abramowitz

Go to main Forum page »

AUTHOR: steve abramowitz on 10/28/2024

As a psychotherapist well-traveled in the talking cure from both sides of the consultant’s couch, I am no stranger to anxiety. And as a former financial advisor, I am well-versed in how it affects financial choices and in particular the decision to select active or passive funds.

Let’s take your friend Dennis, whose attitude toward investing has been shaped by many different and often conflicting factors. Not a completely naïve investor, he listens to inspirational money-making podcasts and watches the market opening on CNBC while brushing his teeth. Suffice it to say, Dennis knows just enough about investing to get him in trouble and keep him from reaching his financial goals.

Failing to run the table with options and individual stocks, Dennis at least knows enough to seriously consider funds as the sensible way to proceed. But the active vs. passive dilemma has him stumped. A math jock, he can interpret the numbers overwhelmingly in favor of the passive strategy, but he can’t get his head around the seeming illogic that no management is the best management. Why can’t he?

Many reasons, starting with our culture’s caricature of the stock market as a dizzying roller coaster more likely than not to let you off at the bottom. What was the mindset around the dinner table at Dennis’s home? Imagine if his grandparents went bankrupt in the Crash of 1929. Or that his tech-heavy education funds were decimated in the dot.com debacle. From those grim family stories, Dennis’s parents may well have preached a strict investment conservatism.

We’ve now had a glimpse of a possible source of your friend’s reluctance to act on two decisive decades of academic research. Fear of devastating loss had been drilled into him in childhood. Without a portfolio manager, full-service broker or financial advisor at the helm, Dennis’s vacations would be tainted by worry. If the conflict in the Middle East erupted into full-scale war, no one would be there to steer the ship.

But does investment anxiety alone explain Dennis’s quandary? Probably not–we’ve yet to consider how his upbringing molded a personality inclined to overvalue the virtues of going active and perhaps seeking out an investment advisor. Dennis’s father took a back seat to his strong-willed mother, who set the rules that included choosing the college her son could attend. Consequently, Dennis grew up dependent on others and insecure in his decision-making.

Low self-esteem meant that Dennis routinely depended on authorities for advice for problems he might well have solved on his own. Of course, delegating responsibility to people more knowledgeable than you are about certain situations often makes good sense. But Dennis’s boundaries were as permeable as a slice of Swiss cheese. When a boisterous acquaintance boasted how her financial advisor had put her into Nvidia just before its price exploded, it was all you could do to convince Dennis not to impulsively contact her to set up an appointment.

I want to relate a true story about how even a temporary lapse in confidence and vigilance can make folks especially vulnerable to industry propaganda that most investors need to work with a financial advisor. Sally and Dave were two of my clients, who were invested in three broad market index funds—domestic (60%) international (20%) and total bond (20%). In other words, they had an 80% stock/20% bond split, the classic Bogelheads 3 fund “lazy” portfolio. When they planned to move from Sacramento, they asked me to transfer their account to a broker in Los Angeles. Doubtful about their ability to monitor their funds while acclimating to their new surroundings, Sally and Dave hooked up with a traditional commission-based firm.

.In the process of facilitating the change, I was informed that the new brokerage house did not accept (no-commission, low fee) index funds. I was instructed to sell them and send over the proceeds. A few weeks later, Sally called to let me know that the transfer had gone smoothly and they invested the cash into three of the same kind of funds but offered by the broker’s own company. At their first meeting with him, they also purchased an annuity.

Those three “same kind” of funds did indeed cover similar investment territory, but they were actively-managed, had an astronomical fee and carried a front-end commission. Besides, both Sally and Dave could look forward to handsome state pensions and did not need an annuity.

Much academic study has established that our investment decisions are often influenced by cognitive biases. Many people are prone to confirmation bias, the tendency to interpret new information consistent with previously held beliefs. In the investment realm, an investor may devalue an earnings forecast that contradicts his own opinion about the company’s potential.

By the same token, your personality traits can affect your investment choices. Whether or not to go with an advisor or full-service broker or to prefer funds run by a portfolio manager should be based on rational considerations, like limited knowledge about the workings of the stock market. Know thyself. Try to weed out anxieties and personal traits that are vestiges of childhood and may no longer apply to your next investment decision.

 

 

 

 

 

 

Subscribe
Notify of
22 Comments
Newest
Oldest Most Voted
Inline Feedbacks
View all comments
Scott Dichter
3 months ago

We don’t even need schools to handle this, there are free online tools/courses that teach the ideas that are needed.

Rick Connor
3 months ago

Steve, thanks for the informative story. I was speaking with a friend and colleague (an excellent engineer who can learn anything he puts his mind to) a few days ago who had the opposite experience of Dan and Sally. He was with an advisor who had him in higher cost index funds. He is starting to dig into persoanl finance (HD is one of his goto sites) and he is starting to ask why he is paying so much for an index fund. He is playing around with some retirement planning tools and is on his way to not needing his advisor. I plan to encourage to get involved in the Forum.

Linda Grady
3 months ago

“One personality trait so valuable to the investor is humility.” Perfectly appropriate here! 😊 I can relate to so much of what you wrote, Steve. My husband (influenced by his parents) was much more motivated in our investment choices by fear rather than greed, unlike my own father who was more aggressive, but still cautious. I remember one time when my dad announced “I don’t like the way the market is looking. I’m going to invest in real estate.” He eventually purchased a total of three private homes in the very nice neighborhood where he and my mother bought our small family home. He never owned more than two rental properties at a time and maintained them himself. He did very well and left a nice legacy (including his good example) for his children and grandchildren. P. S. Eventually he did re-enter the market, but in a modest way, as I recall.

Edmund Marsh
3 months ago

It’s interesting what people think they know or that they have the capacity to know. There are folks who have complete confidence they can gather information or figure out independently how to repair their car or their home, but won’t trust themselves to learn enough to crack the mystery of finance. On the other hand, there are those who consider themselves a medical expert after an hour’s search on the internet, and are ready to advise any innocent bystander.
Maybe money is different. I know for me, investment decisions seem like a mix of emotion and logic. It’s like a limbic vs. cortical tug of war. I’ve made the better choice most of the time, but I still feel the pull of my gut.

Rick Connor
3 months ago
Reply to  Edmund Marsh

Edmund, your “limbic vs. cortical tug of war” phrase made me smile. I love how much HD and its partiicpants can teach us.Good stuff.

bbbobbins
3 months ago

What about if your personality flaws include prevarication/inertia/ laziness? Does that not give you an edge as long as you crack inertia to invest automatically in the first place. Thereafter you’re not prone to dabble too much because of not being able to conclude a better course of action?

Jeff Bond
3 months ago

Steve – I feel bad for Sally & Dave. They went from an honest advisor to someone who must not have been a fiduciary that acted in their best interests. Too bad they didn’t consider continuing with your services remotely.

stelea99
3 months ago

You are obviously the expert on psychology here. I look at how people deal with financial risk from a motivational point of view. Just my opinion, but I think that there are two and only two basic financial drives or motivations; fear and greed. Like trying to pilot a small unpowered sailboat in reverse, you know that the rudder doesn’t want to stay in a neutral position, any little movement of the rudder tends to force it to either a full starboard or full port position. It is very hard to maintain equanimity in the face of all the “facts” about finances that flow through both public and social media. Then when you add a big dose of ignorance about how financial markets operate, and the plethora of investment choices available you have a pretty rotten stew. It takes a lot of courage to sit through a 30-50% reduction in equity markets and do nothing even for people with no psychological issues.

Dan Smith
3 months ago

Steve, this post brings three of my friends to mind. I lightheartedly think of them as white-knuckled bulls; invested but freaking out every time the market corrects. All struggle with and require meds to help with anxiety.
Usually when I read about confirmation bias it relates to politics, but I can easily understand the connection to investing as well.

Last edited 3 months ago by Dan Smith
wtfwjtd
3 months ago

Once a person recognizes a market selloff with a “stocks are on sale this week” mentality, a whole new world of opportunity (and sanity) opens up. Even with my old friend/enemy the local real estate market, I always see and feel there’s a lot more opportunity at hand when prices are depressed, than when prices are sky-high.
But, I didn’t always feel this way, to be honest, and I’m not sure when or how this change of thinking came about. A fascinating subject, for sure.

wtfwjtd
3 months ago

Your training and experience serve you well Steve–I can confirm both of your inferences as fact. The markets have indeed been kind to us these last several years, and my wife and I will soon celebrate our 40th wedding anniversary. A nice, stable base from which to flourish, I agree! And to get to that “next level” as I think of it, some really good education from some very knowledgeable people has been very helpful. Reading John Bogle’s “Little Book of Common Sense Investing” prompted something of a “Eureka!” moment, as well as authors like Ed Slott and the various folks here on HD (yourself included!). And then, you throw in a little life experience of actually living through a few of these market ups and downs, apply what you knew all along,and you’re able to see things in a way you’ve never seen them before. I feel very fortunate in that regard.

Michael l Berard
3 months ago

I feel that once one realizes that for every trade, whether a buy or sell, someone, with just as much or more computing power, etc, is taking the exact opposite side of the trade.

There is zero chance that I am smarter than the person or company on the other side, because that could be Buffett or Fidelity, etc.

A while prior,I actually attempted to read, with comprehension, what Einstein wrote well over a century ago. I felt if I could figure out The Special Theory Of Relativity,” Is The Inertia Of A body A measure Of Its Energy Content?”, et.al, surely I could be a superior investor.

I Googled the papers, and , for a second, I thought I had lost all ability to even read, after all, seeing, ” Zur Elektrodynamik bewegter Korper”, did not inspire confidence.

In a fit of panic , I shouted out, “It’s Greek To ME!, which inspired my bride to join me and gently tell me, ” No, that’s German”. She is a wonderful teacher at The Rhode Island School For The Deaf, and has the patience of Job. Thankfully.

I then received the English version, and the first sentence of the 28 page paper is, ” It is known that Maxwells electrodynamics leads to asymmetries which do appear to be inherent in the phenomena. Game, set match. Oh well. I am guessing he was not talking about former Celtic player Cedric Maxwell.

Free Newsletter

SHARE