Enrich Your Future 24: Why Smart People Do Dumb Things

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 24: Why Do Smart People Do Dumb Things?LEARNING: Past performance does not guarantee future results. Change the criteria you use to select managers. “There are only two things that are infinite, the universe and man’s capacity for stupidity.”Larry Swedroe In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 24: Why Do Smart People Do Dumb Things?Chapter 24: Why Do Smart People Do Dumb Things?In this chapter, Larry discusses why investors still make mistakes despite multiple SEC warnings.The past performance delusionLarry explains that it’s normal for most investors to make mistakes when investing, often due to behavioral errors like overconfidence. Being overconfident can cause investors to take too much risk, trade too much, and confuse the familiar with the safe. Those are explainable errors.However, there’s one mistake that Larry finds hard to explain. Most investors ignore the SEC’s required warning that accompanies all mutual fund advertising: “Past performance does not guarantee future results.” Despite an overwhelming body of evidence, including the annual S&P’s Active Versus Passive Scorecards, that demonstrates that active managers’ past mutual fund returns are not prologue and the SEC’s warning, investors still flock to funds that have performed well in the past.Today’s underperforming manager may be tomorrow’s outperformerAccording to Larry, various researchers have found that the common selection methodology is detrimental to performance. The greater benchmark-adjusted return to investing in ‘loser funds’ over ‘winner funds’ is statistically and economically large and robust to reasonable variations in the evaluation and holding periods and standard risk adjustments.Additionally, the standard practice of firing managers who have recently underperformed actually eliminates those managers who are more likely to outperform in the future.Why Are Warnings Worthless?Larry quotes the study “Worthless Warnings? Testing the Effectiveness of Disclaimers in Mutual Fund Advertisements,” which provided some interesting results. The authors found that people viewing the advertisement with the current SEC disclaimer were just as likely to invest in a fund and had the exact expectations regarding a fund’s...