Investing tribes and the paradox of choice

This post originally appeared on August, 30, 2016 at the CFA Institute’s Enterprising Investor blog. You can stay up-to-date with all of our posts via our daily e-mail newsletter.

The 2016 Summer Olympics just wound down in Rio. The games are an idealized opportunity to bring about “peace through sport.” But my guess is that most viewers are far more interested in watching their own country’s athletes compete and (hopefully) excel. This sort of engagement has an effect. During the World Cup, for example, stock market trading rises and falls based, in part, on how the country’s home team is performing.

Contrary to what you may think, being a sports fan and, by definition, part of a modern tribe is a net positive. According to Daniel Wann, author of Sports Fans: The Psychology and Social Impact of Spectators:

“Scientists have found that being a sports fan can be good for your emotional, psychological and social health.Fans who identify with a local team have higher self-esteem, are less lonely and are no more aggressive as a group than non-sports fans.”

That should not be so surprising. We humans are by nature a tribal people. Even in modern society we look for ways to be a part of a group or “tribe.” The renowned biologist E. O. Wilson wrote:

“Everyone, no exception, must have a tribe, an alliance with which to jockey for power and territory, to demonize the enemy, to organize rallies and raise flags. . . . In ancient history and prehistory, tribes gave visceral comfort and pride from familiar fellowship, and a way to defend the group enthusiastically against rival groups. It gave people a name in addition to their own and social meaning in a chaotic world. It made the environment less disorienting and dangerous. Human nature has not changed. Modern groups are psychologically equivalent to the tribes of ancient history. As such, these groups are directly descended from the bands of primitive humans and prehumans.”

So what does all this have to do with investing? Well, equity home bias, a well-known puzzle in investing, may in fact be a function of our innate tribal nature. While some say home country bias is explainable, most analysts believe it represents a sub-optimal disposition on the part of investors. Yet viewed in the light of our tribal tendencies, “portfolio patriotism” is a perfectly normal response despite its cost to our portfolios.

If home country bias is a macro manifestation of our tribal desires, then a more micro view will show other tribal divisions at work in the investing world. The problem with a tribal approach is that adhering to a group requires an investor to turn off their rational brain in order to maintain coherence with the group. A common example is the so-called “gold bugs,” who see gold prices rising no matter the economic scenario. As Tony Isola writes:

“Investing is one of the worst environments to have a close-minded, tribal attitude. Complex problems cannot be solved by unthinking bands. Investing is a very fluid, open system that draws its energy from unpredictable variables based upon human emotion.”

Investors will often find themselves in one camp or another. A common split is between fundamental analysts and technical analysts. For many, it is anathema for analysts in one group to use techniques of the other. However, an evidence-based approach simply looks for what works, not necessarily what confirms our group affiliation. According to Wes Gray:

“An evidence-based investor will conclude that fundamental and technical analysis strategies can work because they are two sides of the same coin. They are cousins — because they share the common objective of exploiting the poor decisions of market participants influenced by biased decision-making. As Andrew Lo, an influential and forward-looking financial economist at MIT, correctly observes about the debate between fundamental and technical traders, ‘In the end we all have the same goal, which is to forecast uncertain market prices. We should be able to learn from each other.’”

Another reason we may be so willing to pawn our cognitive load off to groupthink is that we, as investors, are faced with an overwhelming amount of data, analysis, and opinions. On a daily basis we are presented with so much content that there is no possible way to take it all in, let alone process it. Choosing a well-defined investment approach, by definition, reduces the number of decisions we need to make. By minimizing the “paradox of choice,” we make our lives somewhat more coherent and manageable.

This is not to say that investing tribes stay static over time. Data and research do make shifts in the population possible. One shift underway is the rise of passive investing relative to active investing. The high profits of active managers are under pressure as assets shift to passive, low-cost index vehicles. Even though this shift seems to have been going on forever, open-end mutual funds in the United States hold substantially more assets than exchange-traded funds (ETFs).

While some firms have embraced these changes, other have dug in their heels. The fact is most businesses, including asset management firms, don’t want to cannibalize their own products. Ben Carlson, CFA, highlights the “strategy tax” that firms must pay to switch business models:

“It’s difficult for individuals or organizations to change their mind about something after they’ve always done things a certain way. People hate to admit that either (a) they were wrong or (b) there may now be a better way of doing things.”

Tribes, investing or not, can grow or shrink over time. At present, the tribe representing low-cost, index-centric investing seems to be on the upswing. The “cost matters consensus” is clearly winning over hearts and minds. As John Rekenthaler, notes, low-cost equity funds not only generate higher returns but they also, on average, have a tendency to stick around, and investors tend to have less poor timing decisions.

The day will come when we find it impossible to believe that investors ever paid a sales commission, or load, on their mutual fund purchases, let alone paid more than a few basis points to have an index fund managed. That day is not yet here. The tribe dependent on these fees is still numerous, vocal, and intent on maintaining its profit margins.

But the day is coming when opinions will flip and the low-cost crowd will become the dominant investing tribe.

Originally published at on September 13, 2016.