The Delusion That Fools Unwary Investors

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The world of investing is fraught with traps for the uninitiated and the initiated alike. Our role at Port Phillip Publishing is to demystify the investment process to enable you to better understand how the markets, economy and investment products tick.

Hopefully this guidance makes you a better investor and a few dollars richer, but more importantly the knowledge saves you the pain of losing a ‘life altering’ amount of money.

Sometimes our zest gets the better of us and the message becomes confusing rather than clarifying.

Fortunately one Daily Reckoning reader took the time to provide me with some valuable feedback:


‘Sometimes I get confused, too easily.  I read your recent article from Vern Gowdie titled………..

‘How to leave wealth to your kids without destroying your family

‘Vern spends much of the article making the case that the stock market is going to tank big time and that cash will be king for years to come and provides a number of compelling reasons why he believes this is so.

‘However well into the article and seemingly in support of his views Vern quotes investing guru Warren Buffett saying,

‘“Give your kids the three skills that have made Warren Buffett the fourth richest person on Earth”

‘As we all well know Buffett has made his fortune from INVESTING IN GOOD COMPANIES AND GOOD COMPANY STOCKS VIA THE SHAREMARKET.  Obviously this flies in the face of all points previously made by Vern.  I don’t get this.  At all.

‘Can you provide some means to clarify what Vern is about. 


Prima facie the message of investing in ‘Cash versus Companies’ is confusing.

Please allow me to explain the investment style behind Gowdie Family Wealth.

Warren Buffet’s style can be distilled into two words — value investing.

Value investing sounds simple enough, yet the vast majority fail to adhere to this basic strategy. Why is that?

After nearly 30 years in the investing business, my experience leads me to conclude there are two contributing factors: impatience and illusory superiority.

The first factor we are all too well aware of.

The second factor is better known as ‘we think we are better than we really are.’

Illusory superiority is the cognitive bias that makes the majority rate themselves as ‘above-average drivers’. Mathematically it is impossible for 85% of drivers to be ‘above-average’, yet most people firmly believe they belong in this category.

The overestimation of ability applies to intelligence levels, personality traits, skill sets, the ability to perform tasks, etc.

Illusory superiority combined with impatience has been the ruination of many an investor. Decade after decade, the market has seen the ‘cocky, quick buck artist’ come and go. With very few exceptions, the market ‘gelds’ them and trots them off with their tails between their legs.

Buffett’s sage advice of ‘be greedy when everyone else is fearful and be fearful when everyone else in greedy’ is a straightforward statement of ‘buy low and sell high’. However, time and again we see the crowd rush in when the market boom is in its ‘eleventh hour’.

The hard data bears witness to this fact.

In the following chart from the Wall Street Journal you’ll see a summary of the findings from the latest annual Quantitative Analysis of Investor Behavior conducted by DALBAR.

The numbers highlight a rather obvious conclusion — investors jumping from hot stock to hot stock leads to substantial long term under-performance.

Fund investors returns fall short of the market
click to enlarge

To put these percentages into cold hard dollars. Here are the results, after thirty years, of an investor with starting capital of $50,000 and an annual savings capacity of $5000.

Investors’ Equity Fund return of 3.69%

S&P 500 Index
return of 11.11%





Impatience and illusory superiority come with a very expensive price tag.

The fact this is DALBAR’s twentieth annual report probably explains why the following excerpt conveys such a strong overtone of frustration in investor behaviour:

‘After decades of analyzing investor behavior in good times and in bad times, and after enormous efforts by thousands of industry experts to educate millions of investors, imprudent action continues to be widespread….Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited.’

In spite of the countless lessons and warnings, the majority of investors are hardwired to self-sabotage their investment capital.

In a demonstration of my determination to defy the futility and ‘correct irrational investor behavior through education’ Gowdie Family Wealth is a disciplined (the quick buck artists would say boring), value-orientated and education based (informed decision making as opposed to herd investing) approach to wealth management.

Lessons learned:

In the cold light of day what are the tried and true lessons on wealth creation?

  1. Identify whether markets are under, fair or overvalued. Understanding the value proposition is a key determinant in making or breaking your financial future.
  2. Besides investment capital, the main prerequisite to be a successful investor is an abundance of patience. Wealth creation is a lifelong pursuit.
  3. Focus more on the RISK — what is your downside. If you do this successfully the REWARD will take care of itself.
  4. Markets will give you what they want to give you when they want to give it to you — whatever rate of return you want or timeframe you want it in is completely irrelevant to the market. The sooner you acknowledge this fact, the quicker you will adjust your mindset to that of a wealth creator rather than being another market hard luck story.
  5. Unless you are Warren Buffett or you can identify the next Warren Buffett, index investing is by far the best low cost, high percentage long term way to invest in stock markets.
  6. Remember, ‘Wall Street [the investment industry] will sell you anything that you’re willing to buy. Wall Street is a legal pickpocket of the average investor.’ – Warren Buffett.
  7. High risk DOES NOT equal High reward. High risk can and does equate to total capital annihilation. Low Risk CAN equal High Reward if you buy low and sell high.
  8. Share markets MAY NOT go up in your investing lifetime. We are approaching seven years since the 2007 high and the Australian share market is still 20% below its 2007 peak. The Japanese share market peaked in 1990 and –24 years later is still over 60% below this peak.
  9. Understand what you are investing in — it must be transparent and contain no hidden, nasty surprises.

How to Identify Value

Warren Buffett has stated the only book an investor needs to read is Benjamin Graham’s The Intelligent Investor.

Benjamin Graham is widely recognised as Buffett’s mentor. We have all heard of the Price/Earnings ratio as a measurement of market value. However, one year of earnings does not necessarily tell a company’s full financial story.

Back in 1934, Benjamin Graham and David Dodd recognised how company earnings can fluctuate wildly depending upon the prevailing business cycle — they had just experienced the Roaring 20s followed by The Great Depression.

Graham and Dodd’s solution was to divide the price by the ten-year average of earnings (smoothing of the lumps and bumps in the business cycle).

In recent years, Yale Professor and Nobel Laureate Robert Shiller has dusted off Graham and Dodd’s P/E 10 formula and adjusted earnings for inflation to develop the Shiller PE.

The following (courtesy of is a screen shot of the present level of the Shiller P/E10 and an accompanying commentary how this compares to the 134-year historical mean.

Shiller P/E
click to enlarge

A P/E10 of 25.2x (the present Shiller P/E10) is in infamous company. The three previous times the P/E 10 has exceeded this level (the red line) are 1929 (prior to The Great Depression), 2000 (prior to the ‘Tech Wreck’) and 2007 (prior to the GFC).

Unless ‘reversion to the mean’ has been made redundant by Bernanke and Yellen, the current market is clearly in overvalued territory. Does this mean it cannot go higher? No.

The market may well go (much) higher, but the corresponding fall to earth will then be much harder.

Conversely the chart provides a very clear indicator on the time to buy into the market — when the P/E 10 is below 10x. A market trading at this level is unloved and fear is in the air. That should be the perfect time to buy.

Watching a stock market rise (especially when the crowd is clamouring to join the party) is a trying time for genuine value investors. The longer the market stays ‘irrationally exuberant’ the more difficult it is to resist its lure…but resist you must. This is the discipline required to avoid becoming one of the market’s sad hard luck stories.

Cash for the Crash

The Gowdie Family Wealth model portfolio is divided evenly between five different asset classes. The model portfolio is where we would ideally like to be invested when the asset classes are identified as being under-valued.

I really do not know when the market will again revert to being a ‘low risk/high return’ proposition. It could happen by the end of this year or it may take another two or more years. Ideally I would love markets to fall 60% or more+ percent tomorrow so I can deploy cash reserves into a discounted asset class, but my wants are irrelevant.

The same goes for investors saying, ‘I’m only receiving 3% percent in the bank but I need 6% percent to give me enough to live on.’ The market could not care less what you require to make ends meet. All that is certain is that once you step outside the security of the bank in search of higher yield you’ve now exposed your capital to the potential of gains and losses.

The average investor focusses on the gain of the extra yield (income) of say 3-–4%three or four percent but has very little comprehension of what potential losses are embedded in the ‘high yield’ product when markets fall on tough times.

Understanding and appreciating that your concerns (income requirements; when you would like to retire; holiday plans, etc.) are of absolutely no consequence to markets is crucial to establishing a realistic financial plan. You can only go as fast as a market allows you to.

So while we are waiting for value to be restored to markets, the Gowdie Family Wealth real-time portfolio is 100% percent cash. We accept the lower return as the price to pay for ‘keeping our powder dry’.’

When (not, if) the markets are flashing ‘green’ we will deploy our cash holdings using a couple of tried and true risk management tools.


Vern Gowdie+
for The Daily Reckoning Australia

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Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.

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2 Comments on "The Delusion That Fools Unwary Investors"

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2 years 5 months ago

I have an additional answer for your reader:

Warren Buffet makes money in stock market crashes by short selling.

Warren Buffet has closed a lot of long positions supposedly. Meaning that a crash is likely.

So quoting Warren Buffet when you think stocks will tank is not ironic at all.

2 years 5 months ago

Also Warren buffet has made the majority of his fortune running hedgefunds, which means you do not lose in a falling market and you still make gains in a rising market. On top of that you collect fees and interest from millions of people and institutions.

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