Chapter 1 - Understanding Advisers and the Industry
Don’t believe everything optimists tell you
If you do, there’s a bridge I’d like to sell you
Here’s a fun fact: every chapter of this book has a rhyming couplet at the beginning. That’s an example of the rhyme and reason effect, which is a cognitive bias that results in a saying being judged as more accurate or truthful when it is rewritten to rhyme. Hey — it worked for Johnnie Cochran, O.J. Simpson’s defence lawyer.
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It goes without saying that people don’t spend time worrying about things that they are oblivious to. This is a book about a problem that hides in plain sight yet persists because so few people recognize it. For about a generation now, there has been a growing body of evidence that traditional economic assumptions and models are flawed. In these models, people are assumed to be sensible and self-aware. In fact, though, all of us are essentially misguided or biased. Many of our choices seem entirely reasonable, yet they often fail when put to the test in the real world. Despite this, many traditional economists act as though their demonstrably incorrect assumptions are reasonable. People who provide financial advice are similarly blinkered. Houston, we have a problem!
Obviously, when financial advice is based on wrong assumptions, the outcomes can be suspect. A paradigm shift is required, and the stakes are high. To date, too few people have recognized the problem. And unrecognized problems are never solved.
Financial goals like improved financial well-being and peace of mind are entirely achievable. We simply need to be more careful when making decisions and to rein in our all-too-human optimism. Doing so may make us feel less comfortable initially, but it will serve us better in the end.
Good financial advisers aim to provide a steady perspective and to give honest and practical advice that is based on empirical data. Unfortunately, throughout their careers, many advisers have internalized modes of thought that impair their ability to realize those objectives. Also, like anyone else, advisers have biases. Advisers are not even remotely immune to them, yet they pay relatively little attention to the impact those biases, if they are even aware of them, may have on the recommendations they make. These
self-professed “behavioural coaches” are themselves in need of behavioural coaching. As a result of this situation, investors who rely on well-intended but misguided advisers are at risk — and it is likely that neither the adviser nor the investor realizes it.
To be clear, this book is not about motives, although there will be a need to contextualize these from time to time. Rather, it is about the potential consequences of bias in human decision-making. It is a book for investors. Good intentions are laudable, but they are not sufficient; biased advice, no matter how well-intentioned it is, needs to be corrected — or, at the very least, acknowledged.
There are dozens of biases out there. While we’ll look at many of them, the one we’ll focus on is optimism bias. It is widely regarded as the “good bias,” because it is thought to be relatively benign. Daniel Kahneman, the world-renowned sociologist and expert on biases and behaviour, has observed, “If there was a fairy godmother that could grant you one wish for your newborn child, you should absolutely ask for optimism/joy.” Not only is optimism seen as a prophylactic against the trials and tribulations in day-to-day life, but it is also seen as something that adds to people’s quality of life in general. In the financial world, optimism is what keeps people invested and steadies their resolve when markets get jittery. Optimism is necessary for setting and attaining goals, maintaining a persistent work ethic, and dealing with challenges. In almost all instances, it is an important emotional and psychological support. Optimism is almost always a force for good.
Bullshift is what results when unwanted optimism is injected into a rational discussion — in the resulting narrative, things seem rosier than they really are. It can be found anywhere people are asked to focus on and imagine the future. It is endemic in the financial services industry but is also typically found in other people-facing activities, like politics. There’s a lot of Bullshift in politics.
Investors often accept the advice of their advisers not because the logic put forward is so compelling but because it is based on a viewpoint that everyone seems to prefer. People simply want happy explanations to be true and are more likely to act if they buy into the happy ending being promised.
Advisers are often so wedded to their optimistic view of the markets that they may be oblivious to the biased nature of it. Your adviser is the product of an industry with a deep-seated, systemic bias that favours perpetual optimism. It is an entrenched part of finance culture. Just as a fish doesn’t know it lives in water because it has never experienced anything different, so too do advisers feel optimistic. Optimism is simply the pre-installed factory default setting. Optimism is generally good for business, and in truth, it is usually good for the investor’s portfolio. But not always.
Boxer Mike Tyson famously quipped, “Everyone has a plan until they get punched in the face.” Similarly, every investor has a plan until they experience a bear market, and good intentions do not necessarily lead to good outcomes. Bullshift is usually the product of “good intentions.” To counteract it, it is necessary to “hope for the best, but prepare for the worst.” To be clear, people should absolutely set positive goals. It’s just that research shows that imagining negative outcomes can lead to better decisions. It’s counterintuitive, but the idea here is to “win by not losing.” We humans would do well to design procedures and make decisions while actively contemplating worst-case scenarios.