Maybe They Aren’t Crazy!

Before getting into a new topic today, I wanted to give you a short update on the progress in spreading the news about managing money the Smart Money with Purpose way.  I’m very excited to have connected with Jonathan Clements, who is the founder of a very successful personal finance site called HumbleDollar. Jonathan was the personal finance writer for the Wall Street Journal for twenty years. As the name implies, HumbleDollar shares a lot in common with my thinking about money, and so I’m very happy to report that you can find some of my recent posts now on HD. If you’d like to check it out, here are a couple of links to recent articles: True Wealth, Life as a Loan Shark.

In addition, I’m pleased to report that after starting from scratch a few months ago, the Smart Money website is growing rapidly in unique visits. I appreciate those of you that are forwarding this email to others or posting links on Facebook and Twitter. It’s gratifying to me to see a steady stream of new subscribers to this newsletter. Thank you for your support in helping spread the word that its possible to liberate the goodness of money in our life! Now onto a new topic.

Maybe They Aren’t Crazy!

When I was ten years old my fifteen-year-old brother convinced me to call a stockbroker up to see if we could invest our hard-earned savings into a couple of stocks he thought looked good: Emerson Electric and Tandy corporation. We didn’t know any stockbrokers, so we did what you did back then and looked one up in the Yellow Pages. My brother, being a shy introvert, somehow convinced me that I was the one that should make the call.

As you can imagine, it wasn’t hard for the broker to realize he was talking to a kid. However, to his credit, he played along and answered all my questions about how buying stocks would work, but explained that I needed someone older to open the account.

My brother and I were very disappointed almost to the point of anger when our parents refused to open an account for us to invest our meager college savings in these stocks. And, you can probably imagine how my brother and I thought our parents were crazy when both of these stocks did very well after our missed opportunity.

Why People Aren’t Crazy

It’s easy for us to put others down for the way they manage their money.  For example, we might say, “He is insane for wanting to invest in Bitcoin.” Or, “You’d have to be nuts to invest in gold!” Or, “Why would anyone invest in bonds today? That is bizarre isn’t it!”

As I’ve grown older, and hopefully wiser, I’ve quit calling people crazy about how they manage their money. First of all, I’ve made enough mistakes myself to be humble. But also, I’ve learned that we all have a dangerous bias with assuming our own experience with money is the way money works. Let me give you some examples of why what may look insane to one person, is actually sound reasoning to another based on their experience.

My parents were children during the Great Depression. They saw the stock market crash and people lose all their wealth. Based on their experience, it made perfect sense to avoid investing in what they saw as the dangerous stock market. On the other hand, stocks have been the place to be in my lifetime. I am very comfortable investing in a diversified pool of stocks because the market has always recovered relatively quickly from any significant decline. My parents experience makes their reasoning sound, but my experience also makes sense of my money decisions that have been much more aggressive.  

Or consider Bitcoin.  Warren Buffett is a smart guy and he thinks it would be crazy to invest in it.  That’s a pretty good reference. But what if you grew up in Zimbabwe? My son bought me a $100,000,000,000 bank note from Zimbabwe a few years ago. It was worth less than a penny in US dollars. The list of nations that devalued their currency to the point of hyper inflation is a long one and if you have lived in one of these countries, or are worried that the US might go down this path, then perhaps Bitcoin or gold begin to look a little more rational.

Even Bankers have Bias

I think I first realized how powerful our own experiences bias our views about money when I taught banking school to young bankers in the 1990’s.  I began my banking career in 1978. Over the next three years we had the wildest movement of interest rates in our history with the prime rate soaring from 8% when I started to 15.5% in 1979 and an eventual peak of 21.5% in 1980. It was crazy!

But when I tried to talk to the young bankers about managing through that time period, all I got was blank stares. They had only experienced single digit rates and I could not convince them that it could happen again. And of course, today, try and tell anyone under the age of 35 that their mortgage rate could go to 15% like it was in the 1980’s. Many assume they will always be able to obtain a mortgage in the 3% range.

Are Lottery Tickets Rational?

Lastly, here is an ugly example of how experience bias impacts some. Probably the worst investment ever is lottery tickets. But look at that decision from the experience viewpoint of someone who feels locked into poverty. They may think it’s the only chance they ever have of escaping poverty, so even with horrible odds, buying a lottery ticket may make sense to someone feeling trapped.

Let me summarize what I’ve been trying to illustrate. We know that our experience represents only a tiny fraction of how the world actually works. But psychologists will tell us that our limited experience gives us misplaced confidence that we understand reality. How can we take this insight into our bias to manage our money better? Let me give you 4 suggestions.

• Remember the ancient wisdom of diversification. The writer of Ecclesiastes wrote these wise words well before anyone every heard of Modern Portfolio Theory: “Invest in seven ventures, yes, in eight; you do not know what disaster will come upon the earth.” No matter how high your confidence is in an investment idea, diversification has been a proven way to lessen risk and maintain wealth over centuries.
• It’s good to give voice to opinions that contradict your own idea. Warren Buffett has been known to invite critics of his company, who are actually betting against Berkshire Hathaway stock, to come to his annual meeting to challenge the decisions he is making. Rigorous debate and challenges to our thinking are a great way to open our minds to potential bias in our thinking. Find a knowledgeable friend who will challenge your thinking.
• Don’t bury your investing mistakes. Study mistakes and learn from them. For example, I was heavily influenced by the arguments of value investing, known for finding stocks trading below their true worth, early in my investing career. That’s not surprising because we didn’t have high tech companies like Amazon back then. The world changed in the 1990’s and I missed some opportunities because of those beliefs. Value investing doesn’t encourage buying high growth stocks with little or no profits. If I had stuck with those value investing principles, I would have missed much of the bull markets because I never would have been able to invest in most technology stocks that put an emphasis on growth over profits.
• Understand your own biases. Psychologists have shown that rather than making investment decisions on goals and appropriate investment options, we are more likely anchored to make decisions based on experiences we had in our early adult life. Think about your own decisions to see if you have been biased in this way.

I would enjoy hearing from you about your experience in overcoming bias in your investing and money management!

Joe Kesler, Smart Money with Purpose