85% of investor decisions are wrong

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VennData
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85% of investor decisions are wrong

Post by VennData » Mon Jan 02, 2012 12:50 pm

Studies of investor behavior tell us some surprising things about the decisions they make. Two results are particularly striking. First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time. Simple random decision making (with no investment knowledge) would have yielded about 50% good decisions.
http://online.barrons.com/article/SB500 ... 98090.html

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iceport
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Re: 85% of investor decisions are wrong

Post by iceport » Mon Jan 02, 2012 1:02 pm

Studies of investor behavior tell us some surprising things about the decisions they make. Two results are particularly striking. First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time. Simple random decision making (with no investment knowledge) would have yielded about 50% good decisions.
This is confusing. Does this mean a tiny minority of investors are making the correct decisions 85% of the time? And that they have huge portfolios, too?

Who are all those people on the other side of those 85% of transactions that are counterproductive?

--Pete
"Discipline matters more than allocation.” ─William Bernstein

livesoft
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Re: 85% of investor decisions are wrong

Post by livesoft » Mon Jan 02, 2012 1:04 pm

More than 85% of investors do not participate in the Bogleheads forum.
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am
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Re: 85% of investor decisions are wrong

Post by am » Mon Jan 02, 2012 1:22 pm

What percentage of investors espouse the Boglehead principles? My guess, about .00000000000000000001%.

anakinskywalker
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Re: 85% of investor decisions are wrong

Post by anakinskywalker » Mon Jan 02, 2012 1:33 pm

am wrote:What percentage of investors espouse the Boglehead principles? My guess, about .00000000000000000001%.
That would be one in 10^22 people, or 1 in 10,000 billion billion people.

Since we have only 7 billion people on the planet, you are in effect claiming that there are no investors who espouse boglehead principles.

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nisiprius
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Re: 85% of investor decisions are wrong

Post by nisiprius » Mon Jan 02, 2012 1:41 pm

Apparently I can't read the article without subscribing, so I'll have to rely on the portion I can see.

"First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time." The obsession of the financial universe with direction and not magnitude is pathological.

I shall scream.

AAAAAAAAAAAAAAAAAAAARGH!

Hypothetically, if 85% of my decisions lost $1,000 each I would be delighted--if my other 15% gained $10,000.

Second, I cannot process the idea that a "sell or exchange decision" is right or wrong. For the life of me, I do not understand how one can determine whether the investor gained or lost unless you consider a completed transaction consisting of a purchased paired with a sale.

Finally, once again, I see numerous claims about naïve investors being wrong more often than right, but I am not inclined to believe any of it until someone can give me a rational explanation of how it can happen, that does not assume that naïve investors have the ability to time the market in reverse. I strongly suspect that the data may be literally correct but that when explained it will turn out to be boring, and not to tell us anything about investing--only about the difficulties of gathering meaningful statistics. (Rather like the scene in which Dilbert arouses the pointy-haired boss to irate action by telling him that 40% of all sick days are being taken on Mondays or Fridays... an accurate statistic that does not mean what the boss thinks it means).
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Re: 85% of investor decisions are wrong

Post by livesoft » Mon Jan 02, 2012 1:45 pm

nisiprius wrote:Second, I cannot process the idea that a "sell or exchange decision" is right or wrong. For the life of me, I do not understand how one can determine whether the investor gained or lost unless you consider a completed transaction consisting of a purchased paired with a sale.
For each transaction that I make, I track it and an alternative decision for a few months. It can be eye-opening.

This is in direct contrast to some folks who say, "Make your decision and never look back." I am always looking back because it tells me not only if my decision-making was wrong or not, but also if it even mattered or was significant enough to really worry about. Over time, I have learned that many of my decisions are not really important to the bottom line.
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555
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Re: 85% of investor decisions are wrong

Post by 555 » Mon Jan 02, 2012 1:46 pm

According to the Pidgeonhole Principle
http://en.wikipedia.org/wiki/Pigeonhole_principle
this means that in at least 70% of trades, both the buyer and seller are wrong!

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Re: 85% of investor decisions are wrong

Post by Muchtolearn » Mon Jan 02, 2012 1:57 pm

I agree with nisiprius and extend it. It is "nonsense" as they would say in a Dostoevsky novel to havec 85% of the decisions being wrong. If so, then all one has to do i do the opposite of what one wants. More likely, since nobody can time the market, the average invcestor would do about the same as a blindfolded money and be right half the time and wrong half the time. Now, if being wrong meant that with brokerage costs one is slightly negative, fine. But then nisiprius's scream comes into play.

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soaring
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Re: 85% of investor decisions are wrong

Post by soaring » Mon Jan 02, 2012 2:01 pm

VennData wrote:
Studies of investor behavior tell us some surprising things about the decisions they make. Two results are particularly striking. First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time. Simple random decision making (with no investment knowledge) would have yielded about 50% good decisions.
http://online.barrons.com/article/SB500 ... 98090.html
I didn't read the article but don't think it necessary. Your title is accurate but not just about investments. A large majority of decisions made are thoughtless decisions and thus usually, but not always, wrong. Most times even when there is thought. I'm included in the 85%.
Desiderata

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Re: 85% of investor decisions are wrong

Post by chaz » Mon Jan 02, 2012 2:03 pm

Glad I'm in the 15% thanks to Mr. Bogle and Vanguard.
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Epsilon Delta
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Re: 85% of investor decisions are wrong

Post by Epsilon Delta » Mon Jan 02, 2012 2:38 pm

This should really read "85% of decisions to decisions to trade are wrong". It does not evaluate decisions to NOT trade.
Personally I make many more decisions to "not trade" than to "trade", that is I am not trading almost every millisecond of every day in every account. This is gazzillions of decisions to not trade per year, compared to the couple or dozens of decisions to trade.

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GregLee
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Re: 85% of investor decisions are wrong

Post by GregLee » Mon Jan 02, 2012 3:17 pm

555 wrote:According to the Pidgeonhole Principle
http://en.wikipedia.org/wiki/Pigeonhole_principle
this means that in at least 70% of trades, both the buyer and seller are wrong!
No, no -- the second example of the Wikipedia article is not about stock-picking, it's about sock-picking.
Greg, retired 8/10.

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Re: 85% of investor decisions are wrong

Post by stratton » Mon Jan 02, 2012 3:57 pm

I don't get the quote in the original post. It has no context for the magnitude of the error. I don't care if I tax loss harvest from TSM into the S&P 500 and I lose 0.25% in returns. The TLH will make up for that problem later in less taxes paid.

A different example would be my play money where I had several MLP CEFs that were bought at a 10% NAV discount and were later sold 16 months later a 10 to 12% NAV premium and the money put into an Intl bond fund. The beauty of this was my equities had become overweight and that fixed some of that rebalancing issue. I probably would have done better to let the MLPs ride for another several months, but I'm not good at predictions and the bond fund was at recent very low point in 2010.

So yes I can see why 85% of changes are "wrong", but are more I should have waited longer.

Then there is really WRONG such as going to all cash in late 2008 and going back into stock in mid 2010. Buy high and sell low is not good financial plan.

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Re: 85% of investor decisions are wrong

Post by dumbmoney » Mon Jan 02, 2012 4:45 pm

nisiprius wrote:Finally, once again, I see numerous claims about naïve investors being wrong more often than right, but I am not inclined to believe any of it until someone can give me a rational explanation of how it can happen, that does not assume that naïve investors have the ability to time the market in reverse.
Think about a large investor who trades randomly. He's going to consistently lose money, not only because of direct trading costs, but because his trading changes the price. His buys drive the price up, and his sells drive the price down. He doesn't have to "time the market in reverse" to lose. He's creating the adverse market fluctuations with his trades.

A single small investor won't move the market, but what if a bunch of small investors share the same biases? In that case they could have the same effect on the market as one large investor trading randomly.
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Re: 85% of investor decisions are wrong

Post by peter71 » Mon Jan 02, 2012 4:59 pm

Re the first paragraph of the article see here:

http://thefinancebuff.com/dalbar-study- ... iming.html

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iceport
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Re: 85% of investor decisions are wrong

Post by iceport » Mon Jan 02, 2012 7:05 pm

For every investor decision to make a sale or exchange there must be an investor decision to buy. Is this not true?

If there were always an equal number of buyers and sellers, only 50% of investors could be making the wrong decisions, correct? So for the statistic to be accurate, there have to be several times fewer buyers than sellers, and they would have to be making larger purchases, on average, than the sellers' average sales. Is this logic faulty?

Thanks,
--Pete
"Discipline matters more than allocation.” ─William Bernstein

555
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Re: 85% of investor decisions are wrong

Post by 555 » Mon Jan 02, 2012 7:30 pm

Interesting discussion. The article is inaccessible. Does anyone know what the article actually says? :oops:

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Re: 85% of investor decisions are wrong

Post by Penguin » Mon Jan 02, 2012 7:51 pm

555 wrote:Interesting discussion. The article is inaccessible. Does anyone know what the article actually says? :oops:
google "barron's the money paradox"
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Re: 85% of investor decisions are wrong

Post by grabiner » Mon Jan 02, 2012 9:30 pm

VennData wrote:
Studies of investor behavior tell us some surprising things about the decisions they make. Two results are particularly striking. First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time. Simple random decision making (with no investment knowledge) would have yielded about 50% good decisions.
http://online.barrons.com/article/SB500 ... 98090.html
The wrong number here is the 50%, not necessarily the 85%. The majority of decisions to sell may lose, but the majority of decisions whether to sell may win. (Selling is right less than 50% of the time, because you pay transaction costs when you sell, and because selling usually implies holding cash rather than a stock which outperforms cash more than half the time.) Converesly, the majority of decisions to buy aer probably right.

Likewise, the majority of exchanges lose money because of transaction costs (and taxes in a taxable account). If you sell X and buy Y, and I sell Y and buy X, we may both be worse off.
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GregLee
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Re: 85% of investor decisions are wrong

Post by GregLee » Mon Jan 02, 2012 10:07 pm

VennData wrote:
First, 85% of sell or exchange decisions are wrong -- the investor would do better by doing nothing or going the other way that 85% of the time.
Interesting, even if not true. I can thank my lucky stars that I am a buy-and-hold person, who never sells or exchanges, so that I can't make that particular kind of mistake.
Greg, retired 8/10.

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nisiprius
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Re: 85% of investor decisions are wrong

Post by nisiprius » Mon Jan 02, 2012 10:18 pm

Penguin wrote:
555 wrote:Interesting discussion. The article is inaccessible. Does anyone know what the article actually says? :oops:
google "barron's the money paradox"
Thanks!

The article doesn't really explain the puzzle, though. Basically it assumes that it is possible to make consistently wrong decisions, then "explains" the factors that lead to them. But you will read serious discussions of gambling that evince exactly the same kinds of description and language. How gamblers make "mistakes," how the pressure of the moment leads them to bet unwisely, etc.

I did like the comment "This is why most successful investors tend to be defensive (strong price discipline), habitually cluster around the middle of the risk spectrum while mostly avoiding its extremes, and follow the adage "Keep your mistakes small."

The problem is that "keep your mistakes small" is like "buy low, sell high:" it's a description of a desired outcome, not a recipe for achieving it.

Notice how well it fits with Charle's D. Ellis' description of investing as a "a loser's game." That is, not a game for losers, but a game in which the winner is not the person who makes the most brilliant moves, but the person who does the best job of avoiding dumb mistakes. Buying and holding an index fund is an excellent strategy for avoiding dumb mistakes....
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Re: 85% of investor decisions are wrong

Post by Tuxx » Mon Jan 02, 2012 10:25 pm

Adjusted for inflation the major indexes have gone no where in over 2 decades, so if you goal is that - good luck with that.

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TrustNoOne
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Re: 85% of investor decisions are wrong

Post by TrustNoOne » Tue Jan 03, 2012 10:17 am

I wonder if the 85% wrong decisions includes the decision a person makes each month when they put their money into their 401k?

In any case, if 85% of investor decisions are wrong, my suggestion would be the not make any decisions.

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Re: 85% of investor decisions are wrong

Post by TheEternalVortex » Tue Jan 03, 2012 11:02 am

It's certainly possible for 85% of decisions to sell to be wrong, if the ones that are right tend to be larger. Another possibility is that in the time period they looked at stocks outperformed cash, and so selling anything was typically a bad idea.

Although I'd really like to see how they determined the decision was "wrong". What is it compared to? Not selling? Selling on a different day?

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Re: 85% of investor decisions are wrong

Post by PreserveCapital » Tue Jan 03, 2012 11:08 am

Can the person who wrote the Barron's article tell us which specific sell or exchange decisions we shouldn't be making in the coming year? :D

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Re: 85% of investor decisions are wrong

Post by 555 » Tue Jan 03, 2012 12:08 pm

The article said nothing about what the 85% refers to so we have to make guesses. Here's another one.

When a trade is made, the buyer and seller between them have zero expected return (minus costs), but they take on risk compared to not acting. It's return-free risk.

An analogy is if the two enter into a coin-toss bet for $1000. Their net expected return is zero, but they take on risk compared to not doing the bet.

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Re: 85% of investor decisions are wrong

Post by Rodc » Tue Jan 03, 2012 12:36 pm

Tuxx wrote:Adjusted for inflation the major indexes have gone no where in over 2 decades, so if you goal is that - good luck with that.
After 21 years of buy and hold, heavy on stocks, I'm up more than 6% on average (XIRR). Inflation has been something like 3%, so about 3% real or a bit more. Historical average might be more like 5% real from such a portfolio.

If I had started back the 1980s I'd be up more.

Not great, but a lot better than "no where".
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: 85% of investor decisions are wrong

Post by GregLee » Tue Jan 03, 2012 12:57 pm

Penguin wrote:
555 wrote:Interesting discussion. The article is inaccessible. Does anyone know what the article actually says? :oops:
google "barron's the money paradox"
Yes, thanks, that got me this reference:
http://online.barrons.com/article/SB500 ... OL_hpp_mag.
That 85% wrong figure is just mentioned as background -- it's not justified in the article. Instead, the author is pursuing a psychological account of why investors often aren't good at being contrarians.
Greg, retired 8/10.

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Re: 85% of investor decisions are wrong

Post by letsgobobby » Tue Jan 03, 2012 1:05 pm

I think you are all overthinking this. My belief (purely an article of faith at this point) is that the great majority of individual investors are temperatmentally predisposed to be terrible investors. They are fearful, greedy, anxious, and all at the wrong times. They generally make bad decisions, and there is money to be made by taking the trade opposite them.

Then there are the professionals. They have worked out some of the above, but now they are competing with each other, which as we know is a zero sum game. So net of fees and expenses, they are not value-adding.

My take home: I can goose returns by being stoic and basically ignoring mass financial media, and by doing the opposite of the masses (in small amounts - not betting the farm) when fear or greed are palpable. Other than that, I should simply index, buy-and-hold, and rebalance, to capture the market returns.

Of course my work makes me somewhat biased, but in general I believe people are poorly-equipped to think long-term. Our terrible national savings rates and the horrific performance of 401ks over a generation support this rather dim view.

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Re: 85% of investor decisions are wrong

Post by VennData » Tue Jan 03, 2012 9:24 pm

555 wrote:According to the Pidgeonhole Principle... this means that in at least 70% of trades, both the buyer and seller are wrong!
Haven't used that one since Computational Math. But I think that the cost of trading can make decisions worse than a zero sum game. So no, trading with costs is NOT zero-sum (ie not separate pigeon holes) As discussed above.

Also, with respect to ones own goals both sides of the trade may be wrong. Meaning the there may be a PHP issue with both sides of a trade being the 'finite' number of options and 'containers' being the trade. I defer to computational mathematicians at this point.

Now if you add the broker, exchange, bank, broker dealer etc... than there are winners who are not part of the decision, but that gets into 'free will.' The key (also noted above) is that each decision is wrong for that investor.

But nisprius et al miss the point, well discussed here, that mutual fund investors as a whole do not grab the returns of the mutual fund as they usually are performance chasing.

As an aside, I recall an often used example for the PHP is sock-picking... 'sock' not stock. LOL

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