Investing against the Odds, and the Facts

Earlier this summer, I was on a hike with a friend and mentioned that while we’d started at about 9,000 feet, we’d reach an elevation of 12,000 feet by the end of the trail. My friend replied, “That’s a fact I just don’t believe.”

Yes, it sounds silly, and of course, we laughed about it. Maybe it was the thin air going to his head, or his good lungs that didn’t cause him to realize how high we had hiked.

But the conversation stuck with me. What is a fact, anyway? Merriam-Webster defines it as “a true piece of information,” and we tend to think of facts as things we can prove through direct observation or scientific experimentation.

For instance, paying 22 percent interest on your credit card while having money in a savings account earning only 1 percent is a bad idea. The numbers make that a fact.

Another fact, proved by the weighty evidence of history, is that it’s very unlikely you can outperform a simple stock market average or index over a long period of time by trying to pick the next “hot” stock or mutual fund. It’s not impossible, but the facts show it’s highly improbable.

The interesting thing about facts is they exist whether we accept them or not. They don’t change simply because we don’t believe them. But once a fact is established as true, we still have a choice. Do we dismiss it? Believing a fact can have all sorts of implications, but perhaps the most important is whether it leads to action.

Let’s go back to the idea of beating the market. I know of no study that contradicts the truth of the high improbability of doing so.

Assume we know this fact and do believe it’s very unlikely we’ll beat the market. Why, then, do so many of us act contrary to what we know and believe? Do we keep betting on individual stocks because we genuinely think we’re the exception? Or do we keep jumping from stock to stock because we like the way it makes us feel?

Asking these questions may well lead to uncomfortable answers about our behavior. But those answers are revealing too. Understanding that we’re doing something because it feels fun, for example, may be a real eye-opener; your actions don’t align with what you know and believe because you enjoy the excitement of tracking stocks and trying to predict what will happen next in the market.

It seems like a small thing, but understanding how you reached this point — acting contrary to what you know is a fact — can help you avoid a similar disconnect in the future. For instance, once you know that you like how it feels to trade individual stocks, maybe you decide to experiment with only a small portion of your money. It’s an acknowledgment of the facts, but it also addresses the reasons you ignored the facts in the first place.

We like to tell ourselves that with enough information, we’ll always make the smart decision. Personal experience has probably shown by this point that facts alone may not always be enough. But learning to understand the relationship between facts, beliefs, and our actions can greatly increase our odds of behaving wisely.

This commentary originally appeared September 15 on NYTimes.com 

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© 2014, The BAM ALLIANCE

Carl Richards, CFP®

Carl Richards is the creator of the weekly Sketch Guy column in The New York Times and is a columnist for Morningstar Advisor. Carl has also been featured in The Wall Street Journal, Financial Planning, Marketplace Money, The Leonard Lopate Show, Oprah.com and Forbes.com. His simple but meaningful sketches served as the foundation for his first book, "The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money."

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