The Investing Revolutionaries

The Investing Revolutionaries: How the World's Greatest Investors Take on Wall Street and Win in Any Market

 

Barry Schwartz Offers a Paradox:

Why Less Is More

 

Dr. Barry Schwartz is a professor of social theory and social action

at Swarthmore College. He joined The Investing Revolution to

discuss his fascinating bestselling book The Paradox of Choice.

The illustration that opens the book finds the professor shopping

to replace a pair of jeans. He gives the salesperson his size and is

immediately peppered with questions: Slim fit, easy fit, or relaxed

fit? Stonewashed or distressed? Button-fly or zipper? Faded or regular?

His response to the salesperson is, “I just want regular jeans.

You know, the kind that used to be the only kind.” The salesperson

has no idea what he is talking about.

    The story ends with Schwartz’s leaving the store with the best-

fitting jeans he has ever had, but feeling worse. The reason, he

says, is that when our choices increase, so too do our standards. In

the past, we may have been satisfied with a pair of jeans that fit just

OK (since they were the only pair available), but now we expect

the perfect fit and the perfect look, all at the perfect price.

    This wide array of options is found in so many aspects of our

lives. When faced with overwhelming choices, Schwartz says we

fall into two separate personality types.

    “A maximizer is somebody who is out to get the best: the best

chocolate chip cookie, the best restaurant, the best jeans, the best

investment, the best job, the best anything. A satisficer is somebody

who is looking for a good enough chocolate chip cookie, pair of

jeans, investment. Good enough can be very good. You can have

high standards, but you don’t need the best.

    “If you’re out to find the best, there’s only one way to get the

best, and that’s to examine all the options. If you don’t examine all

the options, how do you know that the one you didn’t examine

wouldn’t turn out to be the best? If that’s your goal, in a world with

the kind of choices we have, life becomes a nightmare.

 

   “On the other hand, if your goal is simply to find something

that’s good enough, you can look at your cookies or your jeans or

your investments one at a time, and as soon as you find one that

meets your standards, you choose it and you don’t worry about

what else is out there. The distinction between looking for good

enough and looking for the best is not a terribly important one in

a world of limited choices, but in the world we live in, it becomes

increasingly important, and people who are out for the best are,

by almost everything we can measure, pretty miserable.”

   Schwartz uses the example of finding 285 different kinds of

cookies at the grocery store. A daunting choice, no doubt. But what

about the decision involved when you consider choices in the

investing realm? How do you adequately examine the thousands

upon thousands of individual securities and mutual funds avail-

able to individual investors?

   Schwartz includes in The Paradox of Choice a case study involv-

ing participants in 401(k) plans. Of the 1 million people across

1,500 companies researched, there was a striking correlation

between how many people participated in a plan and how many

investing options were available. For every 10 additional options,

participation decreased by 2%. In some cases, Schwartz reports,

employees were passing up as much as $5,000 in matching money

from the employer, all because they couldn’t figure out how to

decide, so they just didn’t. People fail to realize that in so many

situations, any decision is better than no decision.

   The key to overcoming “paralysis by analysis” is to work your

way out of the maximizing state of mind. “It’s maximizers,” Schwartz

says, “who suffer most. It’s maximizers who have expectations that

can’t be met, . . . who worry most about regret, missed opportuni-

ties, social comparisons, . . . who are most disappointed when the

results of decisions are not as good as they expected.”

   While maximizers by their very nature aren’t content to settle

on a decision when a better one might be available, the trick is to

embrace and appreciate satisficing rather than being resigned to it.

All maximizers have had occasions when they’ve been satisficers

simply because maximizing every decision would be impossible.

Maximizers should consider those times in their lives, however

trivial they may seem, when satisficing has been comfortable.

Then, for decisions they’re facing, they should develop standards

for what is good enough. Boil the decisions down to their absolute

minimum requirements.

   This is actually easier in the investing realm than you might

think. A maximizer is going to play Wall Street’s games—picking

stocks, timing the market, and chasing returns—all in the interest

of beating the market. A satisficer, however, knows that there’s

really only one decision to be made: owning the market. Once that

decision is made and the satisficer investor holds a superdiversified

portfolio, the work is largely done.

   “Becoming a conscious, intentional satisficer,” Schwartz says,

“makes comparisons with how other people are doing less impor-

tant. It makes regret less likely. In the complex, choice-saturated

world we live in, it makes peace of mind possible.”

   Whether we like it or not, irreversible decisions in our lives have

to be made with incomplete information. Given that we live in such

an information-laden world, with so much immediate access to

data, this decision dilemma is both ironic and axiomatic. The good

news here, however, is that the satisficing investing decision—to

 own the entire market—isn’t just the “good enough” Schwartz

alludes to. It’s also the best. So, in a beautiful turn of irony, choosing

the satisficing route—not to choose from the thousands of options

Wall Street has laid on the table—the satisficer has chosen the

option the maximizer wants but will never get.

Jason Zweig Explains the Brain:

How Do We Decide?

You see it all the time: the investors who believe that, through care-

ful analysis, extensive research, and tedious calculation, they, and

they alone, have discovered the secret to beating the market.

They’re often seen hunched over laptops toggling between spread-

sheets that calculate numbers based on complex formulas. They’re

dedicated and determined. When I had a conversation with Jason

Zweig, Wall Street Journal columnist and author of Your Money

and Your Brain, he informed our listeners that they’re also half out

of their minds, literally.

   Zweig’s book explores the area of neuroeconomics, which he

describes as being a mix of neuroscience and economics, with a lot

of psychology thrown in.4 It’s an area of study that explores what’s

happening in the brain as financial decisions are made.

   There are two aspects of the brain that Zweig says are often

engaged in a mental tug-of-war: the reflexive brain (the intuitive

side) and the reflective brain (the analytical side).

   Researchers refer to the reflexive brain as “system 1.” It’s the

system that engages and responds quickly—so quickly at times that

the rest of the brain tends to catch up later. It’s the reflexive brain

that will swerve to miss something in the street or pull away when

 something hot is touched. Zweig quotes Matthew Lieberman from

UCLA as saying that the reflexive system gets “first crack at making

most judgments and decisions.”5 Our intuition first screens issues

in order to conserve the rest of our mental energy.

   The other part of the brain is the reflective system. It serves as

the backup system to intuition and tackles more complex prob-

lems. If asked to alphabetize the 50 states, intuition would stall.

When it does, the reflective brain leads to a conscious consider-

ation of the issue.

   But what does all of this have to do with investing? By recogniz-

ing and understanding the two very different ways of thinking, you

can avoid problems that arise when you lean too heavily on one

side or the other. Let’s take a closer look.

   If the reflexive brain were the only thing you used to make

investing decisions, intuition would have you responding emotion-

ally. A drop in the Dow or a surge in a stock’s price can both get

your heart racing and your palms sweating. You may respond by

wanting to pull out of the market quickly or buy up one of its

“rising stars,” but those reactions are intuitive ones. The reflective

side of the brain needs to be engaged to put it all in perspective.

   On the other side of the coin, if you use only your reflective

brain to sort and analyze and compute, you drown yourself in all

the data and numbers available on various investments and thereby

squelch your intuition that would tell you there’s nothing new to be

found. As Zweig says, you “end up losing the forest for the trees—

and your shirts as well.” That is what has happened often to the

investors with the “secret formulas” and extensive spreadsheets.

   Zweig demonstrates the fallibility of our reflective brains with

this illustration. Imagine yourself pushing a cart full of groceries

up to the checkout lane, wondering how much it’s all going to cost

you. Your reflexive (intuitive) side gets a ballpark figure by doing

a quick estimate on the amount of groceries and assigning a cost

based on past experience. Your reflective (analytical) side adds up

the exact price of each item and keeps a running tally in the brain.

“Chances are,” Zweig says, “after the exacting effort of adding

up barely a handful of individual prices, you will lose track and

give up.”

    The reflective system, according to computational neuroscien-

tists who use the principles of computer design to study the human

brain, makes decisions by what’s called a “tree-search” method. It’s

a method named for a standard decision tree. With each decision

made, a whole new set of choices opens up. Your reflective brain

sorts through experiences, predictions, and consequences method-

ically to make each decision. Zweig compares it to an ant “moving

up and down, back and forth, along the branches and twigs of a

tree to find what it wants.” The problem with this methodology is

that it’s limited by your own mind and the problem’s complexity.

    Many investors work hard to engage their reflective brains when

making investment choices, trusting their analysis over their intu-

ition. And, in part, that’s the right choice. However, it’s possible to

tip the scale too far in the other direction and become a victim of

your own limitations. It’s the reflexive side of the brain that intui-

tively tells you many of those efforts are in vain. When that intuition

is stifled, you become like that ant, scurrying along the branches

and leaves of a tree. You can busy yourself with a tedious search for

the answer, but have you considered that the answer may be much

simpler and more obvious than you let yourself believe?

    If you haven’t figured it out yet, Wall Street loves your reflexive

brain mostly because it causes you to make investment decisions

quickly and emotionally. Advertisements that tout the speed with

 which trades can be made are clearly targeting your reflexive brain.

Other approaches that tug at your heart strings or play on fear or

greed (depending on which way the market is headed) are attempts

to influence your reflexive brain and thus emotional actions.

   They don’t stop there, however. If you are of the more reflective

(or analytical) ilk, Wall Street is ready for you too. It continually

rolls out complicated computer programs and products that feed

upon this desire to analyze your investment options ad infinitum

until you feel that you have done adequate due diligence or you

just get tired of the process and pull the trigger. The more complex

a strategy looks to you as a reflective investor, the more credibility

it has with you. Insidiously, Wall Street knows this, and it markets

to it brilliantly.

   Finding the happy medium, a brain balance if you will, is the

key to success. Both your reflexive and reflective brains were

bestowed upon you by our benevolent Creator for a reason. Use

them both, and employ a passive investment strategy that uses

modern portfolio theory and superdiversification. That way, via

owning all free capital markets in your portfolio, you have used a

sophisticated approach that satisfies your need to be analytical and

a system that gives you the confidence that you have done the right

thing by placing your faith in capitalism, which thus fulfills your

intuitive tendency as well.