Andrew Stotz 00:01

Andrew, fellow risk takers, this is your worst podcast host, Andrew Stotz from a Stotz Academy, continuing my discussion with Larry swedroe, who for three decades was at a research at Buckingham wealth partners. You can learn more about his story in episode 645, now Larry stands out because he bridges both the academic research world and practical investing. And today we're diving into a chapter from his recent book, enrich your future, the keys to successful investing. And specifically we'll be talking about chapter 28 which is called buy, hold or sell, and the endowment effect. Larry, take it away. Yeah.

Larry Swedroe 00:33

So I actually wrote a book which we started, I think we went through the first half of it, called investment mistakes even smart people make. I think we covered about 40 of the 77 this chapter talks a lot of about what drives investor behavior and the mistakes that we make. And I use a story or an example from Maya statmans work. Mario stattman is one of the leaders in the field of behavioral finance, which is the study of human behavior and how our behaviors in normal life lead to mistakes investing like we tend to be over confident, as we talked about lots of things. So why shouldn't we expect people to be overconfident about their investment skills? So here's what he had to say in his book, what Investors Really Want. He was explaining that investors want more from their investments than just returns. So he says, investments are like jobs and their benefits extend beyond money. Investments Express parts of our identity, whether that's a trader or gold accumulator or a fan of hedge funds. We may not admit it, and we may not even know what he says, but our actions show that we are willing to pay money for the investment game and and the money is paid for trading commission, mutual fund fees and software that promise to tell us where the stock market is heading. He says, some hedge funds for the and we buy them for the same reasons we buy Rolexes or carry a Gucci bag with their oversized logo, their expressions of status available only to the wealthy hedge funds, he says, offer expressive benefits of status and sophistication and the emotional benefits of pride and respect, those expressive benefits, he notes explain why Bernie Madoff was so successful and so that it's people invest because they want to be a member of the club. When Groucho Marx advice was the right one, I wouldn't join a club that would ever have me as a member. The Bernie Madoff example is a great one. Anyone who did due diligence, in fact, people who had done due diligence on Bernie Madoff even went and reported to the SEC that this had to be a fraud. There was no way. There weren't even enough contracts available to execute what he said, what was being done. And that strategy eventually had to blow up anyway, and the SEC sat there and did nothing for whatever reasons. So that's an example he talks about, and we've talked about the need to believe that we're better than average, when, of course, only half people can be better than average. But doctors, for example, and lawyers, they think, because they're intelligent, that they're better than average. Investors. So my example to them is, well, I graduated top of my class at one of the better MBA programs in the country. Would you let me defend your client in a lawsuit, or would you let me operate on your patient for doing brain surgery? Well, there's a difference between intelligent knowledge and what knowledge do you have that allows you to think that you're not the sucker at the poker table. When you're playing against Warren Buffett and Renaissance technology, you're not playing a game like where your competition is even somewhat sophisticated investors like you and I. You're playing against pros, you know, who have decades of experience, access to the best databases, etc. So there are lots of other mistakes how we frame problems we talk about in the chapter, but these are mistakes that we make simply because we're human beings, and I'll just close. With this the framing the problem. I love this example. He frames a problem like a game of tennis, where you go in your against a practice backboard, and you hit and the ball is bouncing right back to you, and you can hit the strokes and look good. And then you get on the court with the tennis pro, and you know he's just going to crush you if you just get the ball back. And we that lawyers tend to think of investing like hitting the ball against the backboard when you're really playing, you know, against the best players in the world. So you're competing against Carlos Alvarez, not against the backboard. And so who's the sucker at that poker table? Right? It's you, only you don't know it or want to admit it.

Andrew Stotz 05:49

And the word endowment is an interesting one, because it's also, when I think about endowment, I think also about, there's another word, like inheritance, you know, but the one of the questions I would like to ask about this is, how do we separate, let's separate the endowment effect, that was something that has, like, a sentimental value. Let's say, you know, you've talked about different sentimental value possibilities, like, for instance, these are stocks of my company as an example. Or my father, you know, gave me these stocks, and you know, there's a sentimental portion of that. But then you also talk about, just simply, you talked about the wine and how, you know, you buy it at a certain price, and, okay, there's not a sentimental value there. There's just a price, uh, anchoring that's happening. So how do we think about, let's just think now. Let's put that, forget about the sentimental value one for a moment. And let's imagine that, you know, someone's owning a fund, an ETF, maybe a stock. It's gone from 10 to, you know, 50 or 100 and how are they going to let go of the 10 that they bought it for and their connection with it so that they can make the right decision with it going forward.

Larry Swedroe 07:03

Well, there's a lot of things that go on this. This, what's called the house money effect. It's the people in Las Vegas who run the casinos know that when people get ahead, they tend to keep playing, because it's the houses money. And the longer you play, you're putting the odds more and more in favor of the house, because you can get lucky in the short term, but in the long term, the laws of large numbers work against it. You know, you can win a game playing for an hour where you've got the odds of 52 to 48 against you. You can get a string of lucky numbers. You play it for 10 days straight, you're going to walk away with nothing likely, right? Although one out of 100 people might get lucky for a few days, right? So the same thing happens with stocks. I had a friend who would had bought some stock of a company. It was like Qualcomm, and it was like $20 and it went up to 100 and I said, you know, why don't you sell some what could go wrong? I only paid 20 for it. They said, that's no every day you own the stock, you're making the decision to buy it because you could sell it. So the simple way to avoid that endowment effect, or the house money effect, in this case, is ask yourself, would you buy the stock at 100 or in his case, maybe put 10% of his assets in and now it's 50% of his assets. Would you put 50% of your assets in the one stock? And the answer would clearly be No, but the house money effect comes into play. That's a really good way to think about it. Is to ask the question, if I didn't own it. What would I pay for it? And that's what I explained to people, and we use that wine example, and they're just for the benefit of your listeners. Let's say you bought a case of wine, put it away, and you pay $20 a bottle, and five years later, you go to drink it, you find out it's worth $500 a bottle. And most people when asked about that so, well, what would you do with the case? Most people say, Well, I'll put away a couple of bottles and drink it and then go sell the rest. Well, if you wouldn't pay $500 a bottle, you shouldn't drink it. You should sell it and go buy yourself a nice $30 bottle of wine now, right? Because you wouldn't pay 500 right? It's what is it worth today? Well, the same thing should be true of stocks, yep.

Andrew Stotz 09:55

And I like to tell people when they ask me about advice. You. And I generally tell them, Don't ask me about relationship advice, because I've never been married. But I can tell you that I can give you one question about your relationship, and that is simple, knowing what you know now about your girlfriend or boyfriend, which you didn't know when you first connected. Now you know, after a year of being together. If that person walked up to you and you didn't have a relationship, would you start it today? And the answer that needs to be yes or no, and if it's yes, then you need to get back into the relationship and fix the problems that you're talking about. And if it's no, then you know you've got your answer. And so same type of thing at the end of this chapter, you threw in some kind of tidbits, some nuggets. You said that you were talking about capital gains, and you mentioned about donating or setting up charitable trusts. I just curious what, what do you what is the rules around that? Yeah, so

Larry Swedroe 10:55

in the US, anyway, okay, when you own stock and you have a large gain if you go to sell it, okay? To help diversify, you would have to pay a large capital gains tax. Okay, currently, let's say it's 23% and then you might have to pay estate tax. In California, that could be 13 that's a big chunk of your money. So let's say you're a wealthy individual, and you're donating, say, $100,000 a year to a charity, and let's say at a million dollar gain in that stock, you could donate all the shares to a charitable trust, which would then be required under the law to give away, say, 5% of that trust every year, and that trust, because it's a charity, would not pay any taxes at all. So if you're going to give away 100,000 a year anyway, why not take the stock, put it in a trust, and now you avoided the taxes? A lot of people might do that if they're trying to pass value on to their family values onto their children, and set up a trust and say, I'm putting this stock in there, and then we can sell it, because the trust is a travel foundation that's not taxable, and you can use that money in there every year to make your charitable donations, and you're forced to, under the law, to distribute, I believe it's like 5% a year, so it can't sit there forever. And then you're passing on your values. You're forcing them to make decisions about which charities to use might help keep the family together as well, because you can say each of the kids gets a vote who they want the money to go to, and you have diversified those Veer, and they're going to give money to charity anyway. So now it's now your money they're giving, not their own, and they can allow their own investments to grow. And

Andrew Stotz 12:59

the tax benefit is there because the family members in this case, are not the beneficiaries. It's the charities that they're giving the money to. Exactly, okay, but they

Larry Swedroe 13:10

are a beneficiary because they hopefully would have been giving money to charity anyway, and now it's coming out of the trust, and their assets can continue to grow. Yep,

Andrew Stotz 13:21

excellent. That's good little advice. Well, I want to thank you again for another great discussion, and I look forward to the next chapter. And the next chapter is chapter 29 which is the drivers of investor behavior. And for listeners out there. We want to keep up with Larry and all that he's doing. You can find him on x at Larry swedro, and also on LinkedIn. He's out there, always putting out great stuff. So this is your worst podcast host, Andrew Stotz, saying, I'll see you on the upside. You.