The Compound and Friends - The 7 Deadly Sins of Investing

Episode Date: July 10, 2019

FAQ: What are the seven deadly sins of investing? Many of the questions we get from investors revolve around one of these seven mistakes that, if left unchecked, could doom a long-term investing portfolio or retirement plan. Lust! Gluttony! Envy! Pride! Wrath! Greed! Sloth! Michael Batnick, Ben Carlson and Downtown Josh Brown weigh in on each of these sins and why they can be so destructive to investors who aren't aware of them. 1-click play or subscribe on your favorite podcast app   Subscribe to the mini podcast on iTunes or Spotify   Enable our Alexa skill here - "Alexa, play the Compound show!"   Talk to us about your portfolio or financial plan here: https://ritholtzwealth.com/   Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer: https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi, I'm Josh Brown. This is FAQ. We get all kinds of questions from you guys about investing, and a lot of them boil down to a very big mistake that someone either has made or is about to make. And most of those mistakes fit into just a handful of buckets, and we can basically categorize them as seven deadly sins of investing. We're going to get into all of those and more. Stick around. So of the seven deadly sins, let's take these in order. Number one, lust. I view financial lust as the idea of falling in love with a position or falling in love with an idea and not being flexible enough to let it go. What traders lust after are the huge gains. I should have been long Tesla in 2013 or Amazon in 2014 or Netflix in 2015, whatever it is. And these are stories, they're ideas that we tell ourselves that these

companies are going to change the world. And you're always looking for the 10 bagger. You're never going to find it. Move on with your life. I think the other thing that people can sort of fall in love with in terms of investing is having the hindsight bias. So people fall in love with the past and they figure out how to be experts in past market situations. The way I think about that is people who are chasing whatever the hot asset class is, the hot performance, they want to be part of the crowd. It really doesn't even matter what asset class that is. You see that with individual stocks. You see that lately in the S&P 500. You see that in emerging markets, sometimes commodities. And a lot of people will

just go back and forth without even giving much thought to, why am I investing in this? They just see it going up and they're lusting after those returns. Gluttony, overindulgence, the inability to stop. Gluttons usually get punished. There's an old expression on Wall Street where they say, bulls make money, bears make money, pigs get slaughtered. A glutton is a pig and the last thing you want to do is be a pig, especially early in your investing career. I think there's a lot of different ways that you could define financial gluttony. I think one of them is just taking on too much risk when things are going well. If you are over trading and you are not seeing progress and you keep doing the same thing,

you are a glutton for punishment. I was one of these people. I know where you are. Stop it. You want to get into the habit of knowing when you've got too much of a good thing because good things don't stay good things forever. And that can really hurt you as an investor. And the other one is just overindulging on financial porn. So thinking about things like, well, if I would have just bought the Amazon IPO, I could be a millionaire. And oh, if I would have bought like my friend told me to buy Bitcoin in 2013, I just think that that's just like dreaming and wishing you picked the right lottery ticket numbers.

Greed is one of the most debilitating behaviors that an individual investor can exhibit because greed makes you do things that if you're in your right mind, you wouldn't otherwise do. Financial greed comes from things like chasing fad investments and what's doing good today. Something like trying to recreate the magic of the one lucky trade that worked out for you. And so people convince themselves that maybe they have investment skill where a lot of times it was more or less luck than anything. And so I think that's when you can really get greedy. And sometimes investors need to admit to themselves that, hey, I actually got lucky on this investor of this trade and maybe I shouldn't try to do it again. Everyone knows the lion pigs got slaughtered.

What they're talking about are greedy pigs. So let's say that you have a plan in place and you say, I'm buying this stock. I think there's a 30% upside and you nail it. You get that 30%, but you start having second thoughts. Hey, you know what? Maybe I got 40% in this and you get 40%. And then you know what? Maybe this thing is going to get 50% and it's never enough and it derails your plan. That's what greed is. I think investors can get greedy doing things like chasing yield or borrowing money after there's already been a really nice run in the market to try to increase their returns because people think they're owed certain levels of returns every year. And the you know, the market doesn't really owe you anything.

It doesn't give you high returns just because you need them or want them. So if you've got a bucket of cash set aside for something specific, like paying off a student loan or making your first down payment on a house, and then all of a sudden a great investing idea comes along, that temptation to get even more of that investment and take money that you might need in a year, two years, five years, always a huge mistake. Don't be greedy. Sloth is the deadly sin that actually turns me off the most because it's so much more

preventable than some of the others. When I looked up sloth, it said a failure to do things that one should do. So to me, the parallels between investing are obvious. I will start saving for retirement when I get a raise, or I'll start contributing more when my kid gets out of daycare or when they go to kindergarten or whatever it is. It is very easy to make excuses for why today is not the right opportunity to do something. The biggest culprits is the people who say, you know, I'll just start saving when I'm ready. And that's really easy to make excuses for why today is not the right opportunity to do something. The biggest culprits is the people who say, you know, I'll just start saving when I'm ready. And that's really easy to do when you're young and put it off, but you're never really going to be ready. It's just like my friends who try to say, well, I'm going to have kids when I'm ready

financially. And you're never going to be ready financially to do that kind of thing. So you actually just have to do it and start going. So putting off saving for another day sounds great. Well, just once I start earning more money or once I start get that promotion, I think it sounds good in theory. But the problem is there's never really a good time to save. So the best time to save is yesterday, not tomorrow. Sloth is like never bothering to rebalance, being too lazy to do research, looking at the investment markets like I'll get to it someday and never even starting or getting halfway through account paperwork and being like, oh, this is so annoying.

This is too hard. I don't feel like dealing with it right now. Months could go by, years. One of the best things that's happened in the 401k market, so if you're an employee of a company and you have access to an employer's 401k plan, they started doing this auto opt-in feature where you have to actually opt out to not have a portion of your paycheck diverted into your own 401k. And the results since they started doing that have been great. And sometimes that's what's necessary to counteract sloth. I think one of the other forms of financial sloth these days is just doing whatever the headlines say the hedge fund manager is doing. So, oh, look, George Soros is buying puts.

Maybe I should buy puts. Oh, Druck is loading up on gold. Let's back up the truck. Buffett's buying Apple and Amazon. Oh, maybe it's time to kick the tire on those. I think that's just lazy, not doing your research. And I also think one of the other forms of sloth is just allowing a money manager or an advisor to do everything and not understanding exactly what they're doing for you. So I think you can always outsource the management of your money.

That's not a problem. But you can never outsource the understanding of what's going on with it because you still have to pay attention, even if you hand over the keys to someone else, because no one really cares about that money as much as you. So if you don't understand what someone is doing with their money, I think that's a big red flag and a big sign of sloth. Wrath. There is a phenomenon on Wall Street known as revenge trading. In other words,

Apple just killed me. This stock owes me. I'm getting back in. Or shorting something because you hate the CEO's political position. Or trading against another person. You might even know them. You might not know them. You might not know them. Somebody said something that pissed you off. And now, you know what? I'm going to get even. I'm going to make even more money than they did. Or I'm going to buy that stock that they're shorting because they're idiots.

Wrath. I am very familiar with this one. When I think of this in terms of trading, I think of something called revenge trading. You lost money shorting Amazon. Damn it, I want my money back. And you will continue to do the same thing over and over. Stocks don't know that you own them.

They certainly don't know that you're short them. Get over it. They have no affinity to you whatsoever. Do not revenge trade. You don't have to make it back the same way you lost it. I used to have a friend who would go to the blackjack tables with me. And he thought he had a foolproof system that every time he lost, he would simply double his bets. And so he thought that there was no way that he could walk out of there with anything less than he came in with because he'd always break even. So he'd lose a $10 bet and then he'd bet 20. He'd

lose the 20, he'd bet 40. And the problem with that is that once you get on a roll and start losing and losing and losing, the cards don't have to go your way, and so he would just get madder and madder the deeper he went into a hole, and it rarely worked because then he would just start getting angry, and he would even increase his bets even more, and he'd always lose money, and so I think there's this idea when you're investing that you're going to have this revenge trade, and you're going to make all your money back somehow. The other thing is blaming the market for your own faulty decisions. And so it's just, I'm not wrong. I'm just 10 years early. No, you're pretty much wrong. And sometimes if the market doesn't

agree with you, that doesn't necessarily mean all the other people out there are being idiots. It could just mean, you know, maybe you made a mistake. And so the idea that, you know, I'm just going to try harder, that'll fix it. Investing is one of the few places where trying harder actually doesn't lead to better results. And in fact, you could probably argue trying harder leads to worse results over time because, you know, markets don't really award points for degrees of difficulty or effort. So a lot of times actually taking a step back and not trying as hard, especially when you're angry or have lost money, is probably the right move to make. Envy. This one's a killer. And I am susceptible to this one, first to admit it. Being envious of the returns of other people,

being envious of the trades that other people have made that have worked out, this will absolutely destroy you if you let it. Absolutely. Being envious of other people's returns is a sure sign that number one, you're not confident in your own plan, and number two, you're allowing emotions to dictate your actions. I would say that envy is what happens when you watch somebody capitalize on something

that you think you should have capitalized on, and it typically happens, or maybe it's more strongly happens when it's either people you know, your friends, your family, your neighbors. And it's even worse when you see somebody making a lot of money in something and you would consider yourself smarter than that person. You think, oh man, that idiot's making money. I should be making money. And that can lead to all sorts of destructive behavior. Financial envy. So Charlie Munger once said that there's this old saying, what good is envy? It's the one sin you can't have any fun at. It's 100% destructive. And I

completely agree. I think people spend a lot of time worrying about greed and fear in the markets. But I think in terms of your own personal finances, envy probably drives a lot of what people do. And the problem with envy is that not just in your portfolio, but even in your financial life, it can lead to lifestyle creep because you're trying to keep up with the Joneses. You see what other people are buying and you really have no idea what their personal financial statement says and what their personal balance sheet is. So trying to keep up with other people just because they're buying something or they're doing something, a new car, a new boat, whatever it is, worry about your own stuff first and then figure out

what everyone else is doing later because you never have any idea how much debt these people have, how much they're saving, how much income they're bringing in. The worst thing you can do is read articles about investors who have just kicked ass in some stock or some asset class and feel like that should have been me. The next time something like that comes around, I'm not going to miss out. Here's what you're not hearing. All of the mistakes that those traders have made and all the money they've lost in other investments, that rarely enters into the picture. You're hearing about one winner amongst probably a huge pile of winners and losers. It's really, really important you don't go around envying other people. You have no idea what they've been

through, what kind of failure they've had to endure before they found success. And you're going to have to go through that process on your own. Shouldn't worry about what other people have managed to do. I think one of the big problems people have when investing envy enters the equation is they really confuse their time horizon and risk profile with someone else's. And so that leads to these unnecessary and avoidable mistakes because you're making these decisions based on what someone else is doing that has nothing to do with you personally or your personal circumstances. So you're buying things you don't understand and you're using other people's decisions to do them. And it just, it makes no sense. Pride. You buy a stock and you told yourself a story about the company's fundamentals or the stock price or the CEO or whatever.

And then the facts tell you that you're wrong. But you refuse to listen to them because the story that you told yourself, if you're wrong, it contradicts your entire ego, which is married to this company. Pride, hubris, overconfidence, these things have no place in a successful portfolios toolkit. Pride in the investment markets will absolutely take you down. It's really important that you go into every day, every week, every month, and you remind yourself, I don't know anything. One of the people I admire the most in finance, actually a journalist named Jason Zweig. And Jason likes to say, the longer I'm doing this, and he's doing this 30 some odd years, the more I realize how little I actually know. That's exactly the kind

of attitude that I think is missing on Wall Street, but so many people would benefit if they had that as their mindset. You know nothing. And you know why you know nothing? Because yes, there are cycles. Yes, there are themes throughout investing history that repeat. But everything changes. Everything changes. And something that you're absolutely sure of right now may not be the case a year from now. Next year, this year, one really great example of pride, there used to be people that felt that they absolutely knew the right time to buy stocks was when the dividend yield was higher than the bond market. And so that was this thing that prevailed in the 30s and the 40s and the 50s. And you could set your watch

by it. The moment stocks got cheap enough that the dividend yield, let's say it was three or four percent, was higher than the treasury bond, that's the moment to buy stocks. And then you sell when it's the other way. All of a sudden, in the late 1950s, that relationship changed. And people said, oh, you have to sell stocks now because the dividend yield is now lower than the bond yield. And that shouldn't be. Now's the time to sell. If you had sold in 1957, you had missed out on one of the biggest bull runs into the late 1960s. And that relationship never, ever, ever, almost 70 years later, went back the other way. Never. So if you were then saying, well, I know better. I've always done it this way. This is how it works. You absolutely

killed yourself. That's one example. I'll give you 5,000 examples. Don't think you know better, I've always done it this way, this is how it works. You absolutely killed yourself. That's one example. I'll give you 5,000 examples. Don't think you know better than the market. The market is hundreds of millions of people every day who are acting on good information, bad information, old information, new information. You are not in a position that you can reasonably think that you're going to outsmart that on a daily basis, weekly, annual, you're just not going to be that good. And those who are, the period of time for which they're that good, it doesn't last forever. So remember, pride is a huge mistake. Check your

pride at the door. Be extremely humble in the presence of the markets because the market's job is to eventually humble everyone. George Soros has this quote. He says, I'm only rich because I know when I'm wrong. I basically have survived by recognizing my mistakes. And so I think that's the idea you have to figure out is just, you know, it's not what you know that really makes sense in the markets and helps you. It's what you don't know and admitting the stuff you don't know. So there was a story about the famous hedge fund manager Ray Dalio from Bridgewater Associates. And in the early 80s, he was convinced that the US was going into another depression. And it's kind of funny because the timing there, that was basically around the time that started the 20-year bull market, which is one of the biggest bull markets in history.

And Dalio wrote in his book, and he said, you know, I learned some lessons. And he said, this episode taught me the importance of always fearing being wrong, no matter how confident I am that I'm right. And what he did is he sought out other smart people that disagreed with him on a stance so he could form a better opinion. And so, you know, it's not a bad idea to ask for help sometimes in your finances. And, you know, you don't have to pretend that you have it all figured out. And I think the people who do pretend to have it all figured out are either A, delusional, or B, they're just lying to themselves because no one knows what's going to happen. And so I think you have to be willing to say the three most important words in investing, which is I don't know.

Seven deadly sins of investing, lust, gluttony, pride, wrath, envy, sloth. What all of these things have in common is that they are emotional. They're not, these are not financial concepts, these are behavioral concepts. They directly relate to the way that you are as a person. Temperament is so much more important than wisdom or knowledge or skill or ability. Temperament, Warren Buffett would tell you the same thing. Show me an investor with good temperament and I would prefer that investor over, you know, somebody that's got the highest IQ, for example. So if you can keep yourself in check and recognize when you're going through these types of emotions, when you're

feeling envious, when you're feeling prideful, when you think you have it all figured out, that is how you win. You subvert those emotions and avoid those seven deadly sins.