“Hearing a succession of mediocre singers does not add up to a single outstanding performance.” ~Sherwin Rosen
I’m starting this article with a very tough and personal admission: Over the years, I’ve turned into a mediocre investor.
What does that mean exactly? It means I’ve earned poor returns. I would’ve been better off investing in a passive low-cost index fund.
And I’m not alone.
- Did you know that the average investor has consistently earned less than half the rates generated by index funds? (The average annualized return of an equity investor was 3.66% while the S&P grew by an average 10.35% annually over 30 years.) *
- Did you know that the mediocre results were mostly driven by an investor’s own behavior (43%), followed by fund expenses (23%)? *
The study of investors’ behavior may not be important to you. But look at it another way:
There is countless data that can be analyzed to shed light on how people make choices with their financial resources when the outcome is unknown. The findings can be a fair representation of how we make decisions in other areas of life as well.
Why do we perform so poorly when it comes to managing our hard-earned money?
How and why we fall into mediocrity
There are many psychological and behavioral factors that lead us down the path of mediocrity.
No one starts with the goal of becoming mediocre. It happens gradually with choices that turn into destructive habits over time.
Consider the following factors and determine how they influence you when making financial and other decisions (buying a big-ticket item, wanting to change something about yourself, your relationships, or your environment, or seeking new experiences).
Our own psychology
Studies have shown that the biggest reason most investors perform badly is their own behavior. They panic and sell low, feel euphoric and buy at high prices, or try to time the market. The driving force behind these decisions is not reason, but emotion—an investor’s worse enemy.
Research in behavioral finance shows many biases and cognitive errors that contribute to investors irrational behavior. I list below the issues that have contributed to my mediocrity as an example.
Overconfidence: We overestimate our abilities to make good decisions. This means we believe we can beat the market with quick decisions. So, we take greater risks, and trade more aggressively. The smarter you are, the more likely you’ll lose money in the markets—if you’re not careful.
Loss aversion: We hold on to bad choices far too long, hoping that things will turn around. By not selling our losers, we never have to confront our failures. And when we don’t sell a mistake, we’re potentially giving up gains from making smarter investments.
Herding: We imitate what others are doing, even into harmful situations.
Confirmation bias: We give more weight to news and information that support our existing beliefs and ignore the rest. We want to prove that we’re both right and smart.
Overreaction bias: Investors tend to fixate on the most recent information they receive and extrapolate from it. Then, believing they see what others don’t, they make quick decisions based on superficial reasons.
Mental accounting: Our perspective on money changes with the circumstances. We take undue risk in a certain area and avoid rational risk in another. For example, we’ll take more risks with found money than with our own. Click here for more examples.
Thrill seeking: In a fast and furious world with easy access to action and cheap commissions it becomes easy to speculate and trade more frequently.
Take a moment and think about the issues above and how they impact your decisions in general.
- Think you’re smarter and know better than others?
- Refuse to face your mistakes, and admit to being wrong?
- Do something because others are doing it?
- Consider only the information that confirms your point of view and ignore everything else?
- React quickly without thinking deeply about the issue?
- Label and judge outcomes and people arbitrarily?
- Chase novelty and excitement?
Our tendencies and brain circuitry are not the only problem. Two outer forces we contend with on a daily basis make it much easier to live a mediocre life.
Marketing and advertising
When I first started investing, I did it on my own. It took me a long time to research a company and reach a decision since I had to do all the work. So, I started looking for shortcuts and that lead me to premium investing newsletters.
There were so many services that touted outstanding results and how they consistently beat the market. And I felt like a loser. How come I wasn’t able to generate these returns? (In retrospect, I was doing pretty good on my own as a long-term focus investor.)
I got greedy. If they can do it, I’m going all in, and I’m going to become an outstanding investor by following the advice of such services.
Over the years, I’ve paid thousands of dollars for premium subscriptions, and lost a few more thousands in trading losses. I kept convincing myself that I’d do better if I stuck with it (sunk-cost bias and loss aversion kicked my ass).
When I look back, I realize that marketing tactics emphasize highly selective outcomes and ignore the long-term big picture. Also, it’s almost impossible to follow each recommendation, unless one is sitting on limitless amounts of cash.
Marketing feeds on our emotions and desires. It’s not that hard to make quick decisions based solely on feelings.
And then came social media and that took marketing to a whole new level.
Traditional and Social media
Only time will tell how social media will impact our lives in the long run. But right now, its main purpose is making money off your attention. Personalized ads are at your fingertips and frequent updates keep you coming back for more.
Turn on the TV and its more of the same—infotainment engineered to capture your attention and sell more advertising.
In the past decade, our culture has continuously shifted towards the glitzy and shallow.
Who wants to hold a stock for years (boring!), when he/she can get in and out of a trade within hours, or days at best (fun and exciting!)? Over time, the holding period for a stock got shorter, meaning more activity (and costs) and more bad decisions.
Anyone with an online brokerage account can buy and sell stocks within seconds on their cell phone. No one is going to tell you speculation is a form of gambling. And no one is going to stop you from paying for, or following, the latest trends and recommendations that are constantly competing for your attention and dollars.
The above factors (internal and external) make it fairly easy to become unfocused and mediocre decision makers.
This is not meant to discourage you. And it’s not a losing battle. Ultimately, we’re the ones who make decisions; we can unmake them—with deliberate awareness.
To choose differently, we need to extract the lessons of mediocrity and turn them into actionable steps we can take to change course.
In the next article, I’ll share the most important insights that can help us in making rational decisions.
For now, I hope you get to examine the areas of your life where you feel disappointed by the results. And rest assured my friend, there is no mistake that can’t be a valuable lesson. So, no regrets, only wisdom.