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The Science of Investing: Why Aren’t Investors Listening?

Science, in some aspects of our society, has lost its credibility and ability to create not only an understanding and knowledge of factual data but its influence to change behavior.  Beliefs, attitudes, opinions all have more effect in determining what we do and how we act.  Whether considering a healthy life style or how to…

Science, in some aspects of our society, has lost its credibility and ability to create not only an understanding and knowledge of factual data but its influence to change behavior.  Beliefs, attitudes, opinions all have more effect in determining what we do and how we act.  Whether considering a healthy life style or how to invest, our beliefs prevent us from making the better choices in our lives. This is true not only with our money beliefs and biases, but with other areas in life.

A recent study claims between 20-40 percent of cancer cases and half of cancer deaths could be prevented if people would adopt a healthy lifestyle; specifically quitting smoking, avoiding heavy drinking, maintaining a healthy weight and getting a half hour of exercise every day. So why don’t we do these things? Is it only that we don’t trust the science? Or is it the belief that cancer won’t happen to us? Could it be we make a decisions that is counter to what is in our best interests because we don’t feel like doing what is best?

Many of these same questions and emotions influence how and if we invest. Although the science of investing is equally well established, fear, uncertainty, and inertia all play a role in making this decision.  Here is why not investing is harmful to your financial life.

A one hundred dollar bill in an erlenmeyer flask on a white background.

Starting with the research of Harry Markowitz on Modern Portfolio Theory first published in 1952 who later won the Nobel Prize in Economics in 1990, through the awarding of the prize in 2013 to Eugene Fama for his analysis of asset prices their theories have a practical application in the real world of investing.  The Efficient Markets Hypothesis, Random Walk Hypothesis, Capital Markets Research, Multifactor Model, Modern Portfolio Theory have formed a basis for investing over the long term.

Traditionally in actively managed portfolios the focus is on three variables:

  • Identifying mispricing on securities
  • Forecasting the market or market timing
  • Trading in and out of various securities based on mispricing and forecasting

The problem that arises is that the accuracy of the variables comes down to chance. CXO Group’s survey of 6,582 market “guru” forecasts shows an accuracy factor of 46.9%, hardly a winning strategy.  Can any given active manager beat the market in any given year?  Of course but can they do it consistently? No.

So what are the principles of investing that have been proven to work over time for the investor who is looking for lifetime gains?

  • Small over large
  • Value over growth
  • More profitable companies over less profitable peers
  • Asset class diversification

So why aren’t investor’s listening? If you can see yourself in any of the following, it’s time to think about whether your financial goals align with the current way you invest.  Is what you are doing now getting you to where you want to go?

  • Passive investing is not sexy:  How much more enticing is it to think you have the “inside track” or your advisor is an “investment whiz.”
  • I know better: My friend has a proven method that has worked for him.
  • Misunderstood diversification:  Think Jim Cramer’s “Are you diversified” segment on his TV show which focuses on diversification in large cap US stocks: only one asset class!
  • Fear:  Fear of the past (think 2008); fear of missing out and not being right: How many of your friends brag about getting out before the market crash?  The question is: When did they get back into the market? Fear of current events: The world is getting worse I should buy gold.
  • I only compare performance.  This fails to consider the time period.  Any strategy can beat another in a certain period of time.  What works consistently over time is a strategy based on academic research showing dimensions of higher expected returns.

Maybe it’s time to listen to a better way to invest. Just as it is easier to maintain a healthy lifestyle with a personal trainer or support group, investors benefit from hiring a financial trainer who can help them not only make better investment decisions but better money decisions.

About the Author

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Lorraine Ell

CEO and Senior Financial Advisor

As the CEO and co-owner of Better Money Decisions (B$D) Lorraine is excited to help others solve challenging financial problems. For those experiencing dramatic change such as divorce, retirement, or the loss of a loved one she is a dedicated advisor and acts as equal parts investment manager, financial planner, coach, and personal guide. It’s her mission to help families lead their best financial lives.

Author of the book, Bozos, Monsters and Whiz-bangs: Bad advice From Financial Advisors and How to Avoid it!, Lorraine is also frequently quoted in MarketWatch, Investment News, Investor’s Business Daily, Yahoo Finance, and The Wall Street Journal.

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