The costliest mistakes even experienced investors make

Rebecca Choo Quan: Most investing advice focuses on what to do, but the biggest drag on returns is often self-inflicted. From chasing performance to overconfidence, misguided investor behavior can destroy long-term wealth.

Welcome to season two of Better Vantage by Vanguard, a podcast series hosted by Custom Content from WSJ and Vanguard. I'm Rebecca Choo Quan from Vanguard’s Investment Strategy Group. I'm filling in for Christine Kashkari of Custom Content from WSJ.

With me is my co-host Joe Davis, global chief economist at Vanguard, and today we are joined by Barry Ritholtz, co-founder and CIO of Ritholtz Wealth Management and host of the "Masters in Business" podcast. He's also the author of the book "How Not to Invest: The ideas, numbers, and behaviors that destroy wealth and how to avoid them."

In part one of our conversation with Barry, we're going to dig into the root causes of investor misbehavior.

Barry, thanks for joining us.

Barry Ritholtz: Well, thank you, Rebecca and Joe, for having me.

Joe Davis: So, if you're a professional investor, Rebecca, as you know, Barry, you've become a household name. I don't want to embarrass you, but I'm really excited today—how do we go from being good investors to great investors? We may be doing the basics, important basics: saving, trying to keep costs down, but how do I get to the next level?

So, Barry, really thanks. Thanks for taking time.

Barry: My pleasure. And I'll just throw out the first step to becoming a great investor is: Don't be a bad investor. You got to at least start with decent. You know, it's the old Jack Bogle argument… You'll never get alpha if you're not at least getting beta. You're not going to beat the market if you don't at least start with what the market is giving you.

Rebecca: Well, most investment books tell you what exactly you should do, but you took a very different tact, and you were focused on basically why very smart people make some dumb mistakes. Why did you do that?

Barry: "Bailout Nation" came out in 2009 about the financial crisis, and I had a bunch of publishers chasing me to write another book. And every time I sat down to think about a book, you look at the thousands and thousands of finance and investing books that are published every year, literally hundreds of thousands over the past century… So I kind of kept saying we don't need another book telling people what to do. There are plenty. And then during the pandemic, I have all this extra time. I'm working from home five days a week, and I started putting ideas up on a big bulletin board and eventually the light went off. Oh, I don't want to tell people what to do—too much of that. How about let's stop shooting ourselves in the foot. Let's stop making all of these unforced errors. If you avoid all these mistakes, you're better off than 95% of your peers.

Joe: So let's go there. Barry, I think in your book you talk of that early on. You have sections on bad ideas, bad numbers, bad behaviors. So what are some of the things that rise to the occasion? If I'm an athlete, what are the penalties that I'm making that sets my portfolio back?

Barry: The genesis of this came from having read a quote by Charlie Ellison and Charlie Munger, on the same day, someone asked Munger, "Hey, has Berkshire Hathaway been so successful because you and Warren are so much smarter than everybody else?" And Munger's answer was, "We're not smarter than everybody else, we're just less stupid." And that phrase kind of stayed with me. The odds are very much against… You're not going to be the next Warren Buffett or Peter Lynch as a stock picker. You're not going to be a market timer. You're not going to be able to rotate sectors. And so the parallels became really clear. What are the big mistakes we all make? How do we avoid them? And that was the genesis of the book.

Rebecca: Well, some of us know that we don't know enough to be the next Charlie Munger. But then we listen to experts who tell us how we should invest. But you say there's a flaw in that approach as well.

Barry: So, I don't say we should completely ignore people who have insight and an opinion. My advice from the book is: You have to be really selective. Just because some24-year-old French literature producer booked this guest on TV doesn't mean that they're speaking the biblical truth. They're out selling something. That's the next step to ask yourself: What is this person selling and is this something I need to buy? That's another significant factor? Why do we all go on TV? We have products and content we want to sell or appear in social media or online or wherever.

Joe: So, to just expand on that, Barry—because you're in the business as well. You got "Masters in Business", got the big picture.  You're seeing all this commentary, perspectives. How do you filter from a lot of noise out there? Who do I listen to? How do I not?

Barry: First, there's a very robust wall between my long-term financial plan and portfolio and the daily fire hose of news, noise, opinion, commentary. So that's number one. What happens on a random Wednesday morning in 2026 really isn't relative to the average person's retirement in 2046. People kind of forget that. The business of investing distracts us from the practice of investing.

And then number two, just basic economic theory that markets—they may not be perfectly efficient— but they're mostly kind of efficient. And if it's in the front page of the "The Wall Street Journal" or if it's in a widely distributed blog post or social media, it's already in the price.

Then the last thing is, you want to be knowledgeable enough so that you're aware of what's going on in the world, not just as an investor, but as a citizen, as a family member, as whatever, but not so filled with noise that you become overconfident and cocky and think you could trade better than everybody else.

It's so funny… Investing is one of those things that newbies just plunge right into. Nobody would say, "I've never rock climbed, but I think I want to go up the face of this building in Abu Dhabi because it doesn't look that hard." But yet, we plunge right into buying and selling stocks as if there's no skills or qualifications needed.

Joe: Some would say that's overconfidence bias. But then also, we want to be successful. So how do I become more humble in my investing process? And, how do I know I've gone overconfident? I'm scaling that wall and I shouldn’t be.

Barry: The biggest surprise in writing this book was, again and again, I kept coming back, stumbling back to the theme of humility. So I had collected all these stories of the years of these really terrible, not just forecasts, but behavior and decisions. I think starting out with, Hey, I don't know what's going to happen next, but my portfolio has to be robust enough that whatever the world throws at it. And by the way, here's 100 years of things that have happened. So rather than guessing what's going to happen next and aligning my portfolio with that singular possible outcome, assume a range of possibilities. Have a portfolio that can withstand all of those things. That means you're not going to be in the top decile of alpha generators in any given year, but over the fullness of time, just getting what the market gives you over 20 years puts you in the top quartile, and, depending on the year you begin, top decile. So if you want to be a top performer, at least start with what the market gives you and stick with it over the decades.

Rebecca: Sounds like Jack Bogle right there.

Barry: None of this, by the way, is original to me. I read widely and steal aggressively.

Rebecca: What you're talking about doing with investors, it's just reframing their mindset, which you talk about in the book. Is that how we get smarter or are we in to perpetuity going to be subject to these human biases?

Barry: So, I do think investors over the past few decades have gotten smarter. And I have about $20 trillion worth of assets that have flown to large firms, one of which I'm sitting on their campus that have said, "Hey, we can set the cornerstone of people's portfolios with broad market-based indexes. And then whatever else you want to do beyond that, knock yourself out." Investors have said, "Hey, we've had enough of this. Let's just take our money and go home and send a big chunk of it to Vanguard and not play this game anymore."

The best way to beat someone at their own game is to not play that game. And I think a lot of investors have wised up to the fact that not everybody on Wall Street is a fiduciary, not everybody has their client's best interest at stake in their mind. And so you end up with a whole generation that figured it out, and hopefully their children will continue to figure it out, although not to catastrophize. My concern is now we're creating a generation of degenerate gamblers who walk around with a phone...

Joe: You’re talking about gamification.

Barry: Yeah.

Rebecca: And it's even worse than prediction markets.

Barry: Prediction markets are the least of it… It's wait, you're going to bet whether or not they're going to go for it on fourth and two in a football game or is he going to hit this 3-point shot? I like to play a little poker with some friends, that's not relaxing, that's speculating on every play is a cry for help.

Joe: I share concerns around gamification, FOMO, YOLO. I only live once, so how do you do that though, when you feel like I want to have some upside? I hear you, Barry… I'm staying invested. I got my core 401(k), my advisor portfolio, but I wouldn't mind a little lottery ticket effect. How do you approach that? You talk a little bit about cowboy accounts.

Barry: Yes, listen, people follow all these TikTok investors and these various finfluencers. There's an endless fire hose of this sort of stuff. If, and there's nothing wrong with that, if you're interested in that sort of stuff, fine. Pull aside a cowboy account: 3% to 5% of your liquid net worth, go to town.

Scratch that itch. You want to pick stocks, you want to market time, you want to trade options? Have at it. If it goes to zero, well, it was a tiny percentage of portfolio. Thank goodness it wasn't your whole retirement savings.

Joe: Would you put the Black Swan events or that insurance, so to speak? I'll put that air quotes. Did you put that in that category, that bucket for clients?

Barry: There are a couple of portfolios in the world like that... The all-weather portfolio is 25% gold. That does really well when gold does well, and when gold goes through its regular 10, 20, 30-year periods of wild underperformance, it doesn't do nearly as well. I could pick start dates and show whatever I want. Gold is great. Gold is terrible. No, small-caps. So really, there's a lot of cherry-picking. There's a lot of bad numbers and bad analysis out there.

But the idea that some of us really enjoy the game playing, picking stocks, following companies, following products, if you limit the downside and you can leave the rest of your portfolio… In the book, I describe it as leave your real money unmolested and play with this cowboy account to your heart's content that allows that emotional, hey, you think the world's going to come to an end? OK, buy those puts. Buy the Black Swan puts in that account. But we know the long-term money is made by just allowing it to compound. If we can prevent you from interfering with that compounding process, you're way ahead of everything.

Joe: Interesting.

Rebecca: So Barry, if you had to give us your top mistakes that investors make, what would you say?

Barry: Too much noise, we talked about and just the lack of humility. The book talks a lot about how nobody knows anything about what the future is going to bring, and there are some delightful examples from outside of the world of finance. My favorite example as a big music buff is the reviews of The Beatles when they first showed up on Ed Sullivan. They're hilariously, laughably, career endingly bad. And you go back and it's like, wait, what? And if you go back and watch the video of it, they were really good. It turns out that, we're all old and crotchety and stuck in our ways. And that's true if you're a 30- or a 40-year-old music critic unable or unwilling to recognize, "Oh, the world is changing and this is what comes next." As a species, we're really bad at anticipating that. Now apply that to what's going to happen the economy, what's going to happen with the markets, what's going to happen with stocks, bonds, interest rates. We have no idea. And yet we often behave as if we do. That's probably the single biggest source of error in investment.

Joe: That’s saying what we, what I do… no, but I respect…

Barry:  Well, you're not out saying, "Huh oh, sell everything because I think rates are going up."

Joe: That's the heart, Barry.

Barry: It's the second step.

Joe: I love what you're saying though, and I'm totally okay with the challenge. I think what I'm hearing is, but you correct me if I'm wrong, you're the expert here. It's scale your investment decisions relative to the probability of the outcomes. If you truly are humble, which means a range of outcomes, that probably means that I'm probably not overreacting to every data point, every news feed is, am I right?

Barry: Absolutely.

Joe: If you look at a range of outcomes and then scale it. That's generally what I'm saying, that’s our approach.  

Barry: So let me give you an example of what I think is a good kind of forecast. And I'm not just saying this, I had no idea this question was going to come, but I have repeatedly referenced your white paper and your book about how technology moves through the economy, moves through the marketplace. And it wasn't so much a forecast. People looked at AI and thought it was a forecast. But you looked at 100 years of technological innovation and said, "What happens whenever we get one of these big AI-like shifts?" And I'm going to paraphrase you, "Hey, the first phase is the companies, the picks and shovel companies right in the space, they get the boom." But the real value is created in the second phase when that productivity bump, those efficiencies make its way into the marketplace.

Rebecca: Now, one of the things our data also shows is that sometimes after a major stock market meltdown or financial crisis, the next generation of investors who start saving, say in they're 401(k) plans, tends to be a little bit more conservative. So you talk in your book about recency bias. You also talk about survivorship bias and how those are two big flaws. Tell us a little bit more about that.

Barry: Sure. So, we saw in the 2010s, the youngest generation carried a lot of cash. I mean, money market funds, which today are up to something like $8 trillion. So, we saw the boomers and the Gen Xers were overexposed to equity, and their life experience was, hey, equities constantly have stuff thrown at them, but they shake it off and keep going. They lived through the ’87 crash, the dot-com implosion, the great financial crisis, the Gen X and boomers kind of look at, all right, so this is the market cycle, but in the ends it ultimately ends up going up.

Now there's a sequence of returns issue depending on when you retire that may not be exactly true. You don't want to retire in ’03 when you have to start drawing down at market lows. On the other hand, when you see the millennials and the Gen Zs, and I don't even know what they're calling the latest generation, their experience was lots of scandals, dot.com, ’08 flash crash. Gee, do I really trust Wall Street? Do I really trust the market? And so I'm going to… but I trust banks. So I'm going to leave my money in my checking account where it earns exactly 0% interest… that's purely recency bias. Here's what just happened. Let me extrapolate that out to infinity.

Joe: Do you think that's one of the big three… it’s the overconfidence? It's the overconfidence and then it's the recency.

Barry: So, it's more than overconfidence, when we look at the work of Dunning-Kruger and metacognition, which is an academic fancy word of saying how well do we evaluate our own skill set. And it turns out that amateurs are really bad at evaluating their skill set and people who have an expertise are better. Although ironically, sometimes the experts underestimate their own expertise, and the amateur is wildly overestimated. So if you understand what your skill set is, you can stay within it.

Rebecca: Alright, so Joe, share the deep dark secret with us. What was your biggest investment mistake?

Joe: So I was in graduate school. It's the late ’90’s internet boom, and I'm in graduate school. I don't have much money, but I start investing online brokerage, and I buy a few stocks. Anytime I bought individual stocks was years before I'm working here at Vanguard, and I only bought three stocks. One of my buys: Amazon, 1997.

Rebecca: Smart.

Joe: And I sold it in 2001. So the price had gone up double, triple, and then sold it. I cringed to see what it would have been worth today. So again, if it was luck that I picked one of the star returns over the past 25 years, but I tell that to classes: If you're going to do this to stay the course. But also the odds of me having picked that rabbit out of the hat were really low. Yeah, I had familiarity bias.

Barry: I'll share one of my big errors and the data behind it, which is kind of fascinating. And it wasn't luck. I had been using a Mac since grad school myself and somehow wangled an invite to the rollout of this new product. This iPod. Not iPhone, iPod. At the time Apple was $15 a share with $13 cash, so almost no risk. I write up a report. I send it out to the firm. All the brokers start buying it at $15. I see the reports. Wow, these guys love this idea, and the stock starts climbing and at $20, I see all the sell tickets starting to go through. Hey, what are you guys doing? This is just early days. It just came out. At its peak, I said I'm going to show these guys. So I held on to Apple till it tripled. It's $45. So they made 1/3, I made 300x, and I rubbed in everybody's nose. I sold it at $45. That was about 10,000% ago. And had I held on to it, three-for-one split, two-for-one split, three-for-one split, 1,000 shares would be something like $2.9 million. Some ungodly number… but the lesson... And another part of the book, I refer to University of Chicago Alex Imas’ research, where he found that it was called "Buying Slow and Selling Fast" where essentially it turns out that active fund managers create value buying stock and then more than destroy that value in how they sell it. How did he figure this out? Every time a manager would sell a stock, he would randomly sell a different stock from the portfolio and the random sells outperformed the manager-selected sells by 200 to 300 basis points. So it's just an example. Finding a great stock turns out to be as difficult as that is, the easy part. It's how long do you hold it? When do you sell? Is this an Apple or an Amazon or is this a Lehman Brothers or an Enron and it's very difficult to tell the difference, often until it's too late.

Joe: We both made a similar mistake.

Rebecca: And that's it for today's episode. We look forward to having you join us for our next episode of Better Vantage, where we will continue our conversation with Barry.

Christine Kashkari: If you enjoyed this episode and found it helpful, subscribe, and share.

Notes:

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