Richard Thaler’s work in behavioral economics won him a Nobel Prize in 2017. His 2008 book Nudge was extremely influential, helping shape public policies that in turn help people save more and make better decisions in finance, health, and many other fields.
In a short interview with Morningstar earlier this month, he discussed several pieces of wisdom. Investors looking to improve their financial decision-making (and who isn’t?) ought to heed his advice. Here are three must-read quotes from the interview.
1. On timing the market
“We don’t know whether this period is the beginning or the end of the so-called correction.”
The S&P 500 has dropped over 20% since it peaked at the start of the year, meeting the dictionary definition of a bear market. But there’s no way to know if we’ve reached a market bottom and stocks are set to start moving higher, or if we’re still a long way from the bottom.
Investors who sit and wait for a better price will often lose. Thaler points out that in the late 1990s, as the tech bubble was booming, people “knew” those stocks were overpriced. Still, stocks went up throughout the ’90s, and the correction didn’t hit until 2000. In other words, it’s impossible to prove when stocks are overpriced or underpriced.
2. On the history of the market
“There doesn’t seem to be any evidence that we do learn [from the past].”
History is full of examples of how big events affect the economy, the stock market, and human behavior: war, health crises, government debt crises, inflation, asset bubbles, and more.
But humans tend to make the same kinds of mistakes over and over again in the face of those events. We get caught in the frenzy and panic when markets crash. Sometimes we really hurt ourselves by thinking good times will last forever. Was it smart to continually refinance and pull out home equity in the early 2000s? Was it smart to use crypto as collateral on loans in 2021?
Nonetheless, many investors fail to connect the past to the present, or at the very least are unable to act on the lessons from the past (“this time’s different” syndrome). Thaler says many of his students at the University of Chicago today don’t know about the tech bubble of the ’90s. And when he mentions the crash on Black Monday in 1987, “nobody knows what I’m talking about.”
Thaler’s quote echoes what Warren Buffett once said: “What we learn from history is that people don’t learn from history.” Buffett’s point was that it doesn’t matter how smart you are — it’s a matter of discipline and making the decisions you know you should make in the face of uncertainty. And Thaler emphasizes that this is a very difficult process.
3. On the best way to invest your money
“For most individual investors, they are better off using a rule.”
Using a rule (it doesn’t matter exactly what the rule is) will set you up for a successful investing career. If you establish the rules for your investing decisions at a time when markets are relatively calm and your finances are in order, you’ll have a solid framework for how to invest in times of turmoil.
If you establish a well-diversified portfolio, set up guidelines for how to maintain that portfolio, and add money to it over time, you’ll do well.
On the other hand, if you invest based on your instincts, you’ll probably end up underperforming. What makes matters worse is that you never know if success from investing based on your instincts is because they were right or if you were just lucky. A good result doesn’t mean you made a good decision. And it can take years before you know if your decisions were good.
To make good investment decisions, study history, establish a solid set of rules, and stop trying to time the market.
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