Why it’s hard to apologize…to your portfolio

May 25, 2017

Apologizing is difficult.

via GIPHY

It requires us to own up to our mistakes. This puts our sense of self at-risk. Kristin Wong at NYTimes writes:

Mistakes can be hard to digest, so sometimes we double down rather than face them. Our confirmation bias kicks in, causing us to seek out evidence to prove what we already believe.

Confirmation bias is not unique to the financial markets. In general we like the media we consume not the media in general. This alleviates our need to deal with cognitive dissonance. The problem is that in the financial market cognitive dissonance can cost you money and prevent your development. Wong again:

When you refuse to admit your mistakes, you are also less open to constructive criticism, experts said, which can help hone skills, rectify bad habits and improve yourself over all.

The challenge for investors and traders alike is that the financial markets stand still for no one. The Mathematical Investor writes:

Finance is the result of changing human institutions, agents, laws. Unlike physical phenomena, financial markets are an adaptive system. There are no positive laws in finance. Competition means that every edge is doomed to disappear. At best academics may find something that used to work, as the opportunity will be arbitraged away following its publication.

We see this phenomenon again and again in the financial markets. You can see recent examples in venture capital, the commodities markets and in hedge funds. You can call these examples of reflexivity in action or manifestations of the Adaptive Markets Hypothesis. Either way they demonstrate that that markets are always changing and adapting, invalidating our prior beliefs.

An area ripe for future invalidation is smart beta. The hype surrounding this idea (and the ETFs that follow) is at a fever pitch. The bigger issue is that much of what is called smart beta is likely a function of data mining. If we had 10,000 years of data maybe could resolve these issues today but what will likely happen is that for the majority of factors, future returns will disappoint.

Owning up to our own ignorance isn’t easy. Saying “I don’t know” doesn’t come naturally. However every time you acknowledge a mistake and take action you are taking a positive step. Nobody knows whether that decision will turn out to be correct in retrospect. By taking that loss and apologizing to your portfolio you will reduce your stress and guilt and be a better investor in the future.

Abnormal Returns is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

Disclaimer: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities. Please see my Terms & Conditions page for a full disclaimer.


Originally published at abnormalreturns.com on May 25, 2017.