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{"id":9129,"date":"2019-05-04T15:06:17","date_gmt":"2019-05-04T19:06:17","guid":{"rendered":"http:\/\/www.decisionfish.com\/?p=9129"},"modified":"2022-07-31T19:47:03","modified_gmt":"2022-07-31T23:47:03","slug":"negative-alpha-how-investors-can-stop-losing-money-unnecessarily","status":"publish","type":"post","link":"https:\/\/www.decisionfish.com\/negative-alpha-how-investors-can-stop-losing-money-unnecessarily\/","title":{"rendered":"Negative Alpha: How Investors Can Stop Losing Money Unnecessarily"},"content":{"rendered":"\n<p>Alpha is finance-geek speak for&nbsp;<a href=\"https:\/\/www.investopedia.com\/terms\/a\/alpha.asp\" target=\"_blank\" rel=\"noreferrer noopener\">an investor\u2019s skill that allows her to outperform an index<\/a>, like the S&amp;P 500, on a risk adjusted basis. At a recent&nbsp;<a href=\"https:\/\/www.behavioralfinance.com\/nyc-forum?utm_source=Behavior+Fi+Blog&amp;utm_campaign=bd2de83dd3-EMAIL_CAMPAIGN_2019_03_11_11_07&amp;utm_medium=email&amp;utm_term=0_b19ede7c81-bd2de83dd3-555885649\" target=\"_blank\" rel=\"noreferrer noopener\">behavioral finance conference<\/a>, I&nbsp;<a href=\"https:\/\/www.linkedin.com\/feed\/update\/urn:li:activity:6520787822511747072\" target=\"_blank\" rel=\"noreferrer noopener\">sat on a panel<\/a>&nbsp;that addressed the idea of&nbsp;<em>behavioral<\/em>&nbsp;alpha. Our moderator asked, \u201cWhat is it and how do we get more of it?\u201d<\/p>\n\n\n\n<p>I offered the observation that, in a sense, all alpha is behavioral. Whether you follow an algorithm (set of automatic rules) to select investments, decision rules, gut feeling or all three. It is a human who is making the trading decisions. (Even an algorithm is programmed by humans, with all their biases and skills.)<\/p>\n\n\n\n<p>We know that most individual investors create&nbsp;<em>negative&nbsp;<\/em>alpha. Their returns lag indexes. Indeed, a notorious&nbsp;<a href=\"https:\/\/www.businessinsider.com\/forgetful-investors-performed-best-2014-9\" target=\"_blank\" rel=\"noreferrer noopener\">study by Fidelity<\/a>&nbsp;found that the best performing individual accounts were those that the owner forgot about. Indeed, the average retail investor lags major indexes by several percentage points.<\/p>\n\n\n\n<figure class=\"wp-block-image\"><img decoding=\"async\" src=\"https:\/\/i0.wp.com\/thumbor.forbes.com\/thumbor\/960x0\/https%3A%2F%2Fblogs-images.forbes.com%2Fbrettwhysel%2Ffiles%2F2019%2F04%2FBehavior-Gap.jpg?w=1200&#038;ssl=1\" alt=\"Investor returns in stocks and bonds have lagged indexes.\" data-recalc-dims=\"1\"\/><figcaption>Data: Quantitative Analysis of Investor Behavior, 2016,&#8221; Dalbar, Inc. <a href=\"http:\/\/www.dalbar.com\">http:\/\/www.dalbar.com<\/a>. Graphic: Brett Whysel.<\/figcaption><\/figure>\n\n\n\n<p>Investor returns in stocks and bonds have lagged indexes.<\/p>\n\n\n\n<p>At the behavioral finance panel, I argued that the now-classic behavioral economic concepts of cognitive biases and noise can help us understand why negative alpha happens and how to reduce it. We discussed how individual investors and professional traders alike have been known to hurt their results by:<\/p>\n\n\n\n<ul><li><strong>Over-trading:<\/strong>&nbsp;we can be overconfident, too frequently adding and subtracting from investments, relying on an inflated sense of our ability to separate signal (information) from noise. We are&nbsp;<a href=\"https:\/\/en.wikipedia.org\/wiki\/Pattern_recognition_%28psychology%29\" target=\"_blank\" rel=\"noreferrer noopener\">programmed to see patterns<\/a>&nbsp;(even where none exist), based on the&nbsp;<a href=\"https:\/\/en.wikipedia.org\/wiki\/Availability_heuristic\" target=\"_blank\" rel=\"noreferrer noopener\">availability<\/a>&nbsp;in our memories of superficially similar situations, which may not be relevant. Over-trading hurts returns by causing us to miss opportunities while increasing trading costs. Indeed, these costs often exceed the value of any skill even a professional manager may have.<\/li><li><strong>Waiting too long to buy:<\/strong>&nbsp;we may also miss an ideal entry point and buy too late as a consequence of the&nbsp;<a href=\"https:\/\/www.gsb.stanford.edu\/insights\/research-how-fear-missing-out-makes-investors-risk-blind\" target=\"_blank\" rel=\"noreferrer noopener\">Fear of Missing Out<\/a>(FOMO).<\/li><li><strong>Waiting too long to sell:<\/strong>&nbsp;we focus (\u201c<a href=\"https:\/\/www.investopedia.com\/terms\/a\/anchoring.asp\" target=\"_blank\" rel=\"noreferrer noopener\">anchor<\/a>\u201d) on the purchase price of an investment and&nbsp;<a href=\"https:\/\/thedecisionlab.com\/what-can-george-costanza-teach-us-about-making-better-investment-choices\/\" target=\"_blank\" rel=\"noreferrer noopener\">delay selling too long<\/a>&nbsp;because our loss-aversion is just too intense (on the other hand, we sell our winners too soon). Of course, the purchase price is a sunk cost that ought to be ignored: trading decisions are generally about future performance.<\/li><\/ul>\n\n\n\n<p>Noise refers to irrelevant environmental factors that affect our decisions, making them inconsistent and less accurate. Consider the&nbsp;<a href=\"https:\/\/www.economist.com\/science-and-technology\/2011\/04\/14\/i-think-its-time-we-broke-for-lunch\" target=\"_blank\" rel=\"noreferrer noopener\">famous study<\/a>&nbsp;of the Israeli parole board that freed exactly zero prisoners, just before lunchtime, when the board was probably cranky. Also, we know that&nbsp;<a href=\"https:\/\/www.independent.co.uk\/news\/business\/news\/bulls-prefer-sunny-days-9234649.html\" target=\"_blank\" rel=\"noreferrer noopener\">the market tends to be up on sunny days<\/a>.<\/p>\n\n\n\n<p>On the other hand, there\u2019s research that suggests that the right kind of practice,&nbsp;<em><a href=\"https:\/\/medium.com\/the-crossover-cast\/get-better-at-anything-6-steps-of-deliberate-practice-19830bfc9460\" target=\"_blank\" rel=\"noreferrer noopener\">deliberate practice<\/a><\/em>, can improve our performance in many realms of decision-making. Deliberate practice describes a thoughtful and systematic process of acquiring a skill, usually with the help of a coach, who can give you objective, immediate and constructive feedback over a period of many, probably thousands of hours. It\u2019s also important that the context of the decision is regular and predictable so that the learning is actually helpful. While the investment environment may have&nbsp;<a href=\"https:\/\/en.wikipedia.org\/wiki\/Adaptive_market_hypothesis\" target=\"_blank\" rel=\"noreferrer noopener\">some regularities<\/a>, these may be hard to find.<\/p>\n\n\n\n<p>Beginning professional traders may be able to find a coach, and are supported by loads of information and analysis to help them. Individuals: not so much.<\/p>\n\n\n\n<p>The most direct thing individuals can do to reduce their negative alpha, is to trade as little as possible, &nbsp;minimize costs and above all,&nbsp;<a href=\"https:\/\/www.decisionfish.com\/retirement-investment\/\" target=\"_blank\" rel=\"noreferrer noopener\">keep it simple<\/a>.<\/p>\n\n\n\n<p>Everyone I have coached with their personal finances has not invested at all, as a result of inattention, procrastination, loss aversion and lack of financial education. For example, one client put her son\u2019s college fund in a savings account for the past ten years, forgoing the chance to more than double her savings in a diversified portfolio. She just did not know how to get started and hadn\u2019t made the time to learn. This lost opportunity is arguably a much more important source of negative alpha for most people.<\/p>\n\n\n\n<p>In my experience, the first step is some basic financial education. This should include, at minimum, effective budgeting, investing alternatives and debt management. For people with high-cost debt, which means&nbsp;<a href=\"https:\/\/www.msn.com\/en-us\/news\/money\/a-whopping-80-percent-of-americans-are-in-debt\/ar-BBllyhK\" target=\"_blank\" rel=\"noreferrer noopener\">most Americans<\/a>, paying this down should be a top priority, even before investing.<\/p>\n\n\n\n<p>There are many apps that purport to help you save. Indeed, I built&nbsp;<a href=\"https:\/\/www.decisionfish.com\/app\/\" target=\"_blank\" rel=\"noreferrer noopener\">one of them<\/a>. But I\u2019ve learned that many, perhaps most people, need a human coach to get them started. Only then could an app be helpful to maintain good habits such as saving regularly and investing deliberately and at low-cost, while giving one\u2019s biases and noise as little scope as possible to hurt our returns.<\/p>\n\n\n\n<p>In sum, behavioral alpha is about building our skills and knowledge about both the financial markets and our own decision-making processes. The first job is to avoid the costly mistakes. Even if we can get lots of deliberate practice, data, analysis and support, it\u2019s clearly very difficult to trade in a way to beat indexes, after fees and expenses. Certainly, addressing cognitive biases and noise is part of that process. We need to acquire basic financial literacy and keep our investing simple, boring and cheap enough to avoid the worst mistakes. For all of us, getting our behavioral alpha from very negative to close to zero, would be an enormous benefit.<\/p>\n\n\n\n<p>This article originally appeared on April 20, 2019 at <a href=\"https:\/\/www.forbes.com\/sites\/brettwhysel\/2019\/04\/20\/negative-alpha-how-investors-can-stop-losing-money-unnecessarily\/\">Forbes.com<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Alpha is finance-geek speak for&nbsp;an investor\u2019s skill that allows her to outperform an index, like the S&amp;P 500, on a risk adjusted basis. At a recent&nbsp;behavioral finance conference, I&nbsp;sat on a panel&nbsp;that addressed the idea of&nbsp;behavioral&nbsp;alpha. Our moderator asked, \u201cWhat is it and how do we get more of it?\u201d I offered the observation that, &#8230; <a title=\"Negative Alpha: How Investors Can Stop Losing Money Unnecessarily\" class=\"read-more\" href=\"https:\/\/www.decisionfish.com\/negative-alpha-how-investors-can-stop-losing-money-unnecessarily\/\" aria-label=\"More on Negative Alpha: How Investors Can Stop Losing Money Unnecessarily\">Read more<\/a><\/p>\n","protected":false},"author":3,"featured_media":9130,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"content-type":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":true,"jetpack_social_options":{"image_generator_settings":{"template":"highway","enabled":false}}},"categories":[2],"tags":[4,172,171,173,116],"jetpack_publicize_connections":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v21.5 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Negative Alpha: How Investors Can Stop Losing Money Unnecessarily &#8211; Decision Fish: Decide For Yourself<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.decisionfish.com\/negative-alpha-how-investors-can-stop-losing-money-unnecessarily\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Negative Alpha: How Investors Can Stop Losing Money Unnecessarily &#8211; Decision Fish: Decide For Yourself\" \/>\n<meta property=\"og:description\" content=\"Alpha is finance-geek speak for&nbsp;an investor\u2019s skill that allows her to outperform an index, like the S&amp;P 500, on a risk adjusted basis. 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At a recent&nbsp;behavioral finance conference, I&nbsp;sat on a panel&nbsp;that addressed the idea of&nbsp;behavioral&nbsp;alpha. Our moderator asked, \u201cWhat is it and how do we get more of it?\u201d I offered the observation that, ... Read more","og_url":"https:\/\/www.decisionfish.com\/negative-alpha-how-investors-can-stop-losing-money-unnecessarily\/","og_site_name":"Decision Fish: Decide For Yourself","article_publisher":"http:\/\/facebook.com\/decisionfish","article_published_time":"2019-05-04T19:06:17+00:00","article_modified_time":"2022-07-31T23:47:03+00:00","og_image":[{"width":960,"height":640,"url":"https:\/\/www.decisionfish.com\/wp-content\/uploads\/2019\/04\/negative-alpha.jpg","type":"image\/jpeg"}],"author":"Brett F. Whysel","twitter_card":"summary_large_image","twitter_creator":"@decisionfish","twitter_site":"@decisionfish","twitter_misc":{"Written by":"Brett F. 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