I often reflect on this exchange between Patrick O’Shaughnessy and Aswath Damodaran:
O’Shaughnessy: “Why do you think that there are still so many huge pools of capital, we’ll call them LPs, writ-large, that pursue a mostly active investment mandate and strategy. [Why] don’t we have more of the guy from Nevada that just put it all in the S&P 500 or something?”
Damodaran: “Hope springs eternal in human beings. Who wants to be average? Everybody wants to be above average. I don’t think that search is ever going to go away. And in a sense, active investing takes advantage of the fact that you want to be better than average. So, I think as long as that is part of human beings, you’re going to see people trying. And they’ll be attracted by stories of winners. And that’s why in VC and PE, the stories that are promulgated have that selection bias of ‘look how much money you could have made if you had invested in Uber on the ground floor.'”
Investing is mostly a psychological game. The math is typically straightforward; it’s the behavior that’s hard. Damodaran puts his finger on something that goes well beyond investing and speaks to how we’re fundamentally wired. We don’t hear the stories of the thousand companies that raised a Series A and quietly disappeared. We hear about Uber. We hear about Apple at $2. We hear about the friend of a friend who loaded up on Nvidia before anyone was paying attention. Those stories feel instructive. They feel like patterns we could have recognized. They feel, in retrospect, almost obvious.
That’s the trick our brains play on us. Psychologists call it hindsight bias: the tendency to believe, after an outcome is known, that we would have predicted it all along. The path from “risky, uncertain bet” to “of course that was going to work” gets rewritten subconsciously. And every rewritten story justifies a little more confidence about what comes next.
Upside/Downside
The opportunity cost of this thinking is rarely discussed honestly. When a client pursues a concentrated position or an active mandate, the idiosyncratic (or company-specific) risk they’re taking on is often not well compensated. Individual companies falter all the time in competitive markets. The market as a whole, over long periods, has rewarded patient investors with remarkable consistency. That’s not a story that wins hearts at a dinner party. It doesn’t have a protagonist. There’s no moment of conviction, no bold call, no bragging rights.
Bessembinder’s research is instructive here. The stocks celebrated in active investing represent the extreme right tail of a very wide distribution. For every Amazon, there is a Webvan. For every Chewy, there is a Pets.com. Thousands of ventures that consumed capital, time, and opportunity, largely forgotten. For every concentrated bet that paid off, there are portfolios that never recovered from the one that didn’t. We don’t tell those stories, not because they aren’t true, but because they aren’t interesting. Get rich quick always sells.
The winners were not obvious, they just feel that way now. Hope springs eternal, and so does compounding, if you let it!
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CONSIDER
Success is different for each individual. The raw ingredients are mostly the same.
“The law of the farm has never changed. You still have to plow, you still have to plant, you still have to fertilize, you still have to weed, and you still have to water.
No matter how fast the world moves, there are some things that never change. Human nature is, “I don’t wanna have to do all the hard stuff, I just want all the fruit that comes from it.” But your roots determine your fruit.” – Buzz Williams
“I am successful on my own terms. Because if your success is not on your own terms, if it looks good to the world but does not feel good in your heart, it is not success at all.” – Anna Quindlen
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Let’s get after it this week!
Brooks
Brooks Palmer, CFP® is Head of Investments at Root where he helps identify, evaluate, and implement investment solutions tailored to clients’ needs. In Full-Court Press, he breaks down what’s happening in the markets—cutting through the noise and jargon—while connecting it to Root’s core investment tenets so you can make the most of your money and your life!
The examples provided are hypothetical and for illustrative purposes only. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The information presented should not be construed as investment advice or a recommendation to buy or sell any security or implement a particular strategy.
Advisory services are offered through Root Financial Partners, LLC, an SEC registered investment adviser.