We are all biased in many ways. Sometimes it’s a good thing, like when we’re predisposed to give family and close friends the benefit of the doubt, sticking up for them when someone else mentions a shortcoming.
Sometimes it’s bad, like when a certain brand of car cuts us off in traffic and because we’re predisposed to assume that ALL owners of that car are jerks, we assume this particular driver did it just to spite us.
In investing, bias can be extremely costly. Whether we buy stocks because the companies behind them are home grown brands we feel good about, or we time our investing because we believe that at a certain point in the year stocks always go up, our portfolios can suffer long term negative effects.
There have been many studies about how biases like these shape the behavior of individual investors. But there’s less research on the biases of professional money managers, who are supposed to be using research and logic to determine their trades.
A recent study conducted by researchers from the University of Chicago, Carnegie Mellon University, MIT, and Inalytics Limited, looked for evidence of bias in the trading behavior of professional money managers over an extended period of time. Titled Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors, the paper evaluated 4.4 million trades between 2000 and 2016 (a period that included two market crashes and two recoveries).1
In the study’s abstract the researchers state their striking finding: “while investors display clear skill in buying, their selling decisions underperform substantially—even relative to strategies involving no skill such as randomly selling existing positions.”
Or as wealth manager Barry Ritholtz put it so succinctly in his Bloomberg column, “They actually do OK figuring out what to buy. But they need to do a better job unloading stuff.”2
Ritholtz goes on to explain that buying and selling require very different strategies. “Purchase decisions are forward-looking, conducive to an analytical process that seems to be consistent and quantitative. Selling stock is backward-looking; the retrospective nature seems to be susceptible to the kinds of behavioral biases and cognitive errors we typically think of as common among non-professional investors.”
In other words, even seasoned professionals underperform when selling on a hunch, emotion, or according to some present market condition expectation.
The takeaway here for the average investor is that it’s usually not the market that’s the problem, but the investor’s behavior in the market. Knowing this, the prudent investor will want a long-term plan that’s not dependent on lucky short-term guesses. The disciplined approach follows a diverse allocation strategy designed to endure ever-changing market conditions on the way to your ideal outcomes.
Your trusted advisor can help you create a plan along these lines, and help you stick with it over the long-term.
Citations:
1 – https://www.bloomberg.com/opinion/articles/2019-01-15/stock-pickers-know-how-to-buy-but-not-how-to-sell
2 – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3301277
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