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Confirmation, Availability and Additivity: Biases That Can Impact Us All

As I’m sure many of you have heard, Nobel Prize-winning and pioneering psychologist Daniel Kahneman, Ph.D., died in late March 2024. He, along with Amos Tversky, is largely credited with founding and popularizing the field of behavioral economics, which has had a huge influence on diverse fields ranging from psychology to public policy to law to finance.

So, I thought I’d use this space to reflect on three biases that I’ve been thinking a lot about lately that have their roots in the work that Kahneman and his colleagues started. Two of them are classic — confirmation bias and availability bias. One is relatively new — let’s call it the “additive bias” — and has its grounding in the field that Kahneman helped found.

In all three cases, I love thinking about how the central insights apply to modern-day interactions between advisers and clients and how we might improve our lives (and the lives of our clients) if we attend to them more deeply.

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Forget About ‘Timing the Market': Schwab Research Reveals the Optimal Way to Invest

Can investors realistically time the market to maximize returns, especially over the long term? According to a recent study from Charles Schwab, perfect market timing is impossible. The firm’s research showed that most investors are better off investing as soon as possible using a buy-and-hold strategy rather than trying to predict short-term peaks and valleys.

To produce their new study, researchers at the Schwab Center for Financial Research analyzed the hypothetical 20-year returns of five investing strategies using historical S&P 500 data. Each hypothetical investor received $2,000 every year, which they could invest however they like.

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It’s Too Soon to Say the Value Premium is Dead

The underperformance of U.S. value stocks since the Great Recession has received much attention from the financial media, and prompted at least some investors to conclude that value investing is dead. That has led to papers being written, such as AQR’s May 2020 article, “Is (Systematic) Value Investing Dead?” Because the value premium has been much larger in small stocks than in large, we’ll review the performance of small-value stocks compared with broad market indexes. From 2008 through July 2023, while the S&P 500 returned 9.8% per year, the Fama-French small-value research portfolio returned 8.6%, an underperformance of 1.2 percentage points annually. (Fama-French data is from Ken French’s website.)

A Cautionary Tale

We heard the same argument about the death of the value premium in 2000. From 1994 to 1999, the S&P 500 returned 23.6%, annually outperforming the Fama-French small-value research portfolio by 7.2 percentage points. However, the declaration of the death of the value premium was premature. From 2000 to 2007, while the S&P 500 returned 1.7%, the Fama-French small-value research portfolio returned 16.2%, outperforming by 14.5 percentage points annually. Such performance should be a cautionary tale for those declaring the death of value.

If the underperformance of the value premium in U.S. stocks since 2008 was a sign that value was dead, we should see similar underperformance outside the U.S. From 2008 through July 2023, the MSCI EAFE Index returned 3.2%, but the Dimensional International Small Cap Value Index returned 5.2%, outperforming by 2.0 percentage points annually. In emerging markets, while the MSCI Emerging Markets Index returned 1.7%, the Dimensional Emerging Markets Targeted Value Index returned 4.1%, outperforming by 2.4 percentage points. Thus, outside the U.S., investors who diversified their portfolios to include small-value stocks benefited.

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