Improving Investor Behavior: Quit beating yourself up

Netflix has a new documentary chronicling the Bernie Madoff story. My wife and I aren’t the biggest TV watchers, but we started the series at the recommendation of a friend. If you haven’t heard the name, Madoff was the architect of arguably the biggest Ponzi scheme in history, carefully orchestrating the flow of billions of dollars into his private equity fund while falsifying returns and documents to fool his investors.

What may seem less familiar is his history and deceptively clean background. For a great while, Madoff was the head of the NASDAQ stock exchange. He worked closely with regulators, even going so far as to pen rules and regulation for the industry. With connections in both private and public entities, in many ways he appeared to be as legitimate as they come.

This façade caused regulators to turn away from facts when evidence effectively proved Madoff’s wrongdoings. As a result, he was able to perpetuate his crime far longer, and with more impact, than if he’d lacked these credentials. Caught in his ongoing lies, many lives were affected, with most of them never fully recovering the monies they’d lost at his advisement.

What gave him away was not the shady office on the floor below his, nor his questionable investments or strategies, but rather his returns. Simply put, they went from good to great, then to impossibly great, then to mathematically impossible. Either he was a stock-picking god among men, or he was full of bologna. And yet people continued to invest. They chased the returns Madoff was “providing,” and in doing so, perhaps turned a blind eye to reality.

Let me be clear; it is not my intention to blame the victims of his crimes. Many average (and above average) investors were simply caught up in his scheme, and for that I can’t blame them. It is human nature, and human nature is a poor investor. But part of the reason his fund grew as quickly as it did was simple: greed. When a person starts to receive an outsized return for little additional risk, they in turn will want to tell their friends. Their friends want in on the action, and just like that, greed and the fear of missing out become fuel for the fire. In Madoff’s case, few people were able and willing to take a step back to ask how he was able to do what he did. Eventually, his whole scheme crumbled.

Chasing returns is rarely a winning move. Be it investing in an impossibly great money manager or attempting to “beat the market” yourself, the chances of success are slim. Extensive time, energy, and brainpower goes into this effort each year by professionals and amateurs alike. Whether it’s private equity, ETFs, newsletters, chat groups or any other countless venue, history and math indicate that very few participants consistently beat the market over any measurable period. Our insistence that we can beat the market often instead results in long-term underperformance, meaning we are essentially kicking ourselves in the shin every time we try to get one up on the world.  This is because no one knows what the stock market will do on any given day, let alone at any point in the future. Sometimes investors guess right; usually they guess wrong.

This type of behavior seems completely irrational, given the other side of the coin: the broad markets have historically always gone up given a long enough time horizon. Most people would be better served by refraining from constantly trying to beat the market and instead working with the market, based on historical trends.