Behavorial economists or "neuro-economists" are all the rage these days thanks to books like Freakonomics, Nudge, Think Slow, Think Fast etc. And while I enjoy these books as much as anyone, an oft repeated refrain among these economists is that you are just as well off asking a monkey to choose your investments as you are doing it yourself. And God forbid you pick your own stocks, as the author of Freakonomics alluded on CNBC the other day, you may as well get a gun and play Russian Roulette instead.
Their reasoning is that we frail humans are at the mercy of our mammalian brains - too driven by greed and fear and prone to following the herd (and other shortcomings too numerous to detail) - rendering us incapable of making rational economic choices, especially when it matters most. While this all makes for good sound bytes, of genuine interest to me is what these economists have invested in and how those investments have performed. It's one thing to make money talking about money (or by having a lucrative salary like most finance professionals), it's another thing all together to invest your own dough.
With this in mind, I'd like to introduce my two monkeys named Stefan and Elena. They put this portfolio together three years ago (at age 10 and 12), which is a portion of the money they saved and earned for college, with the intention of holding it through college at the very least. The portfolio is geared towards dividend and dividend growth stocks. The rules were: buy, hold, reinvest the dividends. Any investment that appreciates more than 50% sell some of it. If the investment has a precipitous fall (over 15%), revisit its dividend policy - if you think it can reliably keep paying its dividend buy more or hold and reinvest (earning more shares at a much lower price).
This portfolio was meant to be a learning experience for them. Well, it turned into a learning experience for me. Their three year annualized real return (adjusting for 2% inflation) is 24.6% per year, their cumulative real return is 86%, almost doubling their money when all dividends are accounted for*. They have outperformed around 90% of all hedge funds in Barron’s Hedge Funds list - and they weren’t even making 2% and 20% as an incentive!
Anecdotally, the most eye-opening of these “2 and 20” hedge funds has to be Clarium Capital, founded by Peter Thiel of Facebook fame. Clarium, launched on the back of the financial crisis in 2008, saw its fund assets shrink 90% by 2011, as they posted massive double digit losses year after year. Thiel serves as a reminder that even the so-called “smartest guys in the room”, or on the Street, often get it wrong.
Now, the real lesson here is why my two children outperformed most professional investors:
- There’s no “currency” or kudos in having a great portfolio in junior high school. So, investing is just something one does to earn a return and stave off the effects of inflation; it’s not a competition, they aren’t doing it get attention or to buy a house in the Hamptons;
- They have better things to do than watch their portfolio performance. They shrug at the mere mention of their returns. They are far more concerned with working out at the gym, socializing, music and other such fun compared to us tedious adults. So by default, they are patient;
- They know they are not investing geniuses. So, they keep it simple because they have to. They choose simple strategies, simple investments and occasionally rely on outside help with one or two trusted sources;
- They had paper losses of 20-25% two months after they invested on the back of the Euro crisis. They learned that they can only control how they react to the market; they cannot control the market itself. So, they are practicing Zen-like emotional control, while appreciating the beauty of reinvesting dividends on downturns; and
- The Holy Grail: Children do not come to the investing table with the many hang-ups, neuroses and biases that adults do. To name just a few: political, cultural, religious biases, "scarcity mindsets" and "get rich quick" ego. So, they are more flexible economic animals than adults whose hardened biases often lead to extreme and disastrous investing positions.
The real test of the methodology (and of our mettle) will not be in even five or ten years, but more like in 20 or 30 - if they can maintain a portfolio of investments and make use of the income streams without spending their capital. My teenagers’ outsized returns have to make you wonder exactly which investors these economists are referring to when they speak of monkeys outperforming investors. Maybe they are talking about all those hedge fund guys that milk your pension funds to maintain their own lifestyles; monkeys may certainly be outperforming them.
* * * * *
This article is not advocating how to invest, or who to invest with. It is advocating that anyone can learn to invest once you develop the right habits, discipline and mindset. Overcoming your Monkey Brain takes work, diligence and practice. In an investment world driven by short term greed and myopia on a good day, these are uniquely human attributes critical for over-riding the monkey and developing healthy, sustainable long term investing habits.
* My teens have been tasked with updating their spreadsheet (I’m not going to do it for them) which they do when they feel like it. They are at least one year behind in accounting for dividends. They have also reinvested their dividends, but they choose to break them out for the sake of tracking “how much income they are making” so their real, real return is much higher, and I’ll attempt to post a companion spreadsheet with the final totals over the summer.