Monument Wealth Management Articles

Stacking the Odds in Your Favor: Behavioral Finance 101

Dec 10, 2021 Investing & Portfolio Strategies

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What Las Vegas Teaches Us About Investing

What a topic! Behavioral Finance has become a field unto itself. The study of how the mind and the market meet has spawned Nobel Laureates, quantitative hedge funds, and an army of spreadsheet warriors running untold sums of money on Wall Street.

For our inspiration today, we will quote the famed investment guru and former heavyweight champion, Mike Tyson. “Everyone has a plan until they get punched in the face.”

We find the topic of behavioral finance to be at the heart of why we exist as a firm. Investing is hard. However, when you add the complex and unpredictable nature of human beings, investing becomes harder still. After all, our own behavior determines our success more than any other factor, in every area of our lives—including our wealth.

Life is complex. There are lots of moving parts and it takes a lot more than just tallying up numbers to figure it out. Investing is not solely a spreadsheet-driven endeavor. Investors vary greatly across a multitude of factors, ranging from their time horizon for accessing their funds, their risk tolerance, their tax status, their social signaling, and countless other reasons why investors transact in the market.

For anyone who has seen the movie “The Hangover,” you’ll know that Mike Tyson lives in Las Vegas. The city is famous because the odds are stacked against you. And anyone who is overly emotional about investing probably has the same odds of success as going to the casino and playing the slots. Emotional investing often leads to many pitfalls, including but not limited to: over-diversification (which can lead to suboptimal performance or style drift), overtrading, losing patience, or worse still, becoming a Reddit trader. Said another way: don’t play the slots…

Nah, I don’t play slots. Roulette is my game.

Those looking for excitement in both investing and casinos often want some semblance of control. Unlike slots, playing roulette can be somewhat less random. Seasoned roulette aficionados don’t play a single number. They often spread their bets.

For instance: when investing, you wouldn’t put all your capital in one stock, which is akin to playing one number. You would diversify. In roulette, players often place chips on a multitude of options ranging from odd/even, black/red, alongside individual numbers or groups of numbers. They diversify across the board. In investing, one component of diversification can mean investing in an index in conjunction with individual securities.


Behavioral Setback: Anchoring Bias

However, Roulette players, like stock pickers, tend to suffer from anchoring bias. Roulette players tend to play specific numbers, combinations, or colors…just as stock pickers will stick to specific sectors and stocks and will routinely average down into losing investments. Both the Casino and Wall Street make money from these tendencies, which are rooted in our behavioral biases.


Forget Roulette, I play Blackjack.

OK! Now we’re getting somewhere. Blackjack has some of the most favorable odds in the casino for the player. In most casino games of Blackjack, the house advantage is approximately 8% percent. The house gets this advantage by merit of the dealer being the last player to act. However, by correctly using a basic strategy, a Blackjack player can diminish the casino’s edge from approximately 8% down to ~0.5%. The house still has an advantage – that is, you can still catch a bad sequence of cards – but it’s been greatly diminished.


Behavioral Setback: Sequence of Returns Risk

In wealth management, we call this “sequence of returns risk.” This risk is real for retirees and emotionally driven investors. If you allow emotions to dominate your decision-making process, then you will either a.) increase your bets during a losing streak (i.e. averaging down), or b.) walk away before you can catch a few favorable cards (i.e. a bull market). Everyone has a plan until they get punched in the face.

Become the Casino

If the odds are stacked against you in a casino, then stop playing games and instead become the casino. Casinos don’t try to make money by going all in on a single game, player, or bet – they play the odds over and over again, slowly and diligently picking up dollar bills in a probabilistic, calibrated and systematic fashion from emotional, uninformed participants. It’s why they comp high rollers everything from rooms to meals and shows…to get them to stay at the casino longer.

Monument Wealth Management has a similar view. We remove emotion from the decision-making process, eschew short-term, news-driven strategies, avoid anchoring bias, manage sequence of returns risk, and protect precious emotional capital by managing money in a rules-based, disciplined, systematic fashion. We know that there is no such thing as possessing 100% perfect information 100% of the time—and instead we distinguish between possibilities and probabilities.

We manage money and build wealth plans by becoming the house – not by betting the house. We let cold, calculating rules guide our decisions to minimize the behavioral pitfalls that make us human. We play the probabilities, put good odds in our favor, and stick with a long-term plan. Our razor-sharp fiduciaries design customized Private Wealth Designs with bespoke portfolios, custom to each client’s big picture. We offer straightforward, unfiltered opinions and advice, not just numbers on paper. And this is what differentiates us from the legions of jargon-heavy factories in the industry.

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