The Evidence-Based Investor

Tag Archive: lake wobegon effect

1. We can’t all be above average

   August 16, 2021 12:15 am Comments Off on We can’t all be above average

    

    

   Robin writes:

   Here’s an interesting conundrum. As every TEBI reader knows, beating the market over the long term on a cost- and risk-adjusted basis is extremely hard to do. On average, actively managed funds underperform the index by about as much as the fees and charges they extract. David Blake at the Pensions Institute in London has spent much of his career analysing fund performance and calculates that only around 1% of them genuinely beat the market. And yet so many people in the investing industry are keen to tell you how they’ve outperformed by x or y per cent.

   So, what’s going on here? Are those people lying? Or are they self-delusional? Well, either of those is possible. A third explanation, I point out in my latest piece for the Betafolio blog, is that they’re being very crafty and choosing a benchmark that makes them look far more successful than they actually are. After all, we can’t all be above average — and we certainly can’t all be in the top 1%.

    

    

   “Welcome to Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.”

   Garrison Keillor, A Prairie Home Companion

    

    

   We all like to think of ourselves as being better than average. Let’s face it, whether it’s driving, cooking or deciding who should take the penalties when the scores are level after extra-time, most of us think we’re pretty good.

   The truth, of course, is that, regardless of the activity, half of us have to be below average. But good luck telling your spouse that they’re sub-par in the parallel parking or, heaven forbid, the bedroom department.

   This phenomenon is sometimes known as the Lake Wobegon Effect, after the author and broadcaster Garrison Keillor, who famously poked fun at people’s reluctance to see things as they really are. And it’s certainly alive and well in the investing industry. 

   All the time we hear pension funds, asset managers, investment consultants and financial advisers say, “We’ve beaten the market by x per cent.” Most people simply take their word for it, and I used to be one of them.

   But anyone with a passing knowledge of academic finance, the SPIVA scorecard from S&P Dow Jones Indices or Morningstar’s Active/Passive Barometer knows to take these sorts of claims with at least a pinch of salt.

   CLICK TO READ THE REST OF THE ARTICLE

    

    

   Robin is a regular columnist for the Betafolio website. Here are some of his other recent posts:

   Genuinely bespoke portfolios are largely a myth

   Why you should avoid investment themes

   Index funds DO care about ESG

   Spotting tomorrow’s fund stars is very hard

    

   PREVIOUSLY ON TEBI

   Investing’s untapped market: people with simple needs

   A duration-based explanation for equity factors

   Always seek a second opinion

   What degree of corruption is acceptable?

   The 1% advice fee is toast

   Factor drift: what it is and how to tackle it

   Can you change your mind about money?

   Don’t be fooled by private equity returns

    

   Picture: Charles Deluvio via Unsplash

    

   © The Evidence-Based Investor MMXXI

    

    

2. We’re not as good as we think we are

   November 21, 2017 10:59 am Comments Off on We’re not as good as we think we are

   There’s a cognitive bias, widely recognised in the field of social psychology, called illusory superiority. In fact, it’s been called many things — leniency error, the superiority bias, and the primus inter pares effect, for example — but it’s perhaps most popularly known as the Lake Wobegon effect, named after the fictional town created by the author Garrison Keiller.

   In short, it refers to our natural tendency to overestimate our own capabilities. In Lake Wobegon, “all the women are strong, all the men are good-looking, and all the children are above average”. The truth, of course, is that we can’t all be above average, but that still doesn’t stop us thinking, for example, that we’re better at driving, funnier or smarter than other people.

   Read the full article on InvestWithETFs.com

    

   

    

   ROBIN POWELL is the founder and editor of The Evidence-Based Investor. A freelance journalist, he runs Regis Media, a specialist content marketing consultancy for financial advice firms around the world. You can follow him on Twitter and on LinkedIn.

   The Evidence-Based Investor is produced by Regis Media, a boutique provider of content and social media management to financial advice firms around the world. For more information, visit our website and YouTube channel, or email Sam Willet or Christina Waider.

    

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3. Liberation comes from admitting we were wrong

   September 1, 2017 11:37 am Comments Off on Liberation comes from admitting we were wrong

   “One of the greatest frustrations for me,” writes the investment author Larry Swedroe in his latest post for ETF.com, “is that, given the overwhelming amount of evidence against active management, a majority of investors keep playing a loser’s game.”

   I’ve written about this on TEBI many times, but what is Larry’s take on it? He actually presents four explanations.

   The first, he suggests, is that “the education system has totally failed the public”. Ideally, young people would learn about investing and the financial markets in school and college. In the event, “many obtain their ‘knowledge’ about investing from the very institutions — Wall Street and the financial media — that don’t have their interests at heart, because the winning strategy for them is when investors play the game of active investing.”

   Secondly, Larry blames people’s unwillingness to invest the time and effort to learn what they need to know. So instead of reading a book by, say, William Bernstein or Jack Bogle, they prefer to listen to the financial gurus trying to predict the future on the likes of CNBC. “There’s an all-too-human need,” says Larry, “to believe there is someone out there who can predict the future and thus protect us from uncertainty.”

   The third explanation Larry gives for why investors continue to ignore the evidence is “the Lake Wobegon effect — the need and/or desire to be above average”. Of course, we all like to think of ourselves as being above average. High net worth investors, in particular, want to feel special.

   “Wall Street plays on that need,” says Larry. “You hear the repeated lie that goes something like this: ‘Indexing is a good strategy, but it gets you average returns. You don’t want to be average. We can help you do better than that.’

   “The truth is that indexing doesn’t get you average returns; it gets you market returns. And because it does so with lower costs and greater tax efficiency, by definition, you earn above-average returns.”

   I agree with Larry Swedroe on all three of those points. But it’s his fourth and final explanation for why people continue to use active funds that I found most interesting. It’s to do with self-justification.

    

    

    

   

    

    

    

   In his post, he quotes a book by social psychologists Carol Tavris and Elliot Aronson called Mistakes Were Made (But Not By Me). “Most people,” the authors wrote, “when directly confronted with proof that they are wrong, don’t change their point of view or course of action but justify it even more tenaciously. Politicians, of course, offer the most visible, and often tragic, examples of this practice. We even stay in an unhappy relationship or merely one that is going nowhere because, after all, we invested so much time in making it work.”

   As Tavris and Aronson point out, self-justification, by itself, is not necessarily a bad thing. “It lets us sleep at night,” they write. “Without it, we would prolong the awful pangs of embarrassment. We would torture ourselves with regret… We would agonise in the aftermath of almost every decision.

   “Yet mindless self-justification, like quicksand, can draw us deeper into disaster. It blocks our ability to even see our errors, let alone correct them. It distorts reality, keeping us from getting all the information we need and assessing issues clearly.”

   We’re seeing plenty of self-justification at the moment from the active fund industry and from advisers and another investment professionals who advocate active strategies. The figures for active fund performance are bad and they’re getting worse. But because livelihoods and profit margins are threatened, the industry will continue rehearsing the same old myths, and refuting the evidence ever more vigorously.

   Active investors, on the other hand, both retail and institutional, have a choice. You can carry on repeating the same old mistakes, or you can admit those mistakes, change course and increase your chances of achieving your investment goals.

   Be honest. This is a relationship that promised much but has probably delivered little. It may have worked for your adviser and the different fund managers they’ve recommended over the years, but it hasn’t worked for you. It’s time to walk away.

   Admitting you’ve got it wrong isn’t easy. But it’s liberating, and active investors will almost invariably find themselves better off financially for doing so.