In this interview clip from Motley Fool Live, recorded on March 21, Dan Egan, Vice President of Behavioral Finance and Investing at Betterment, talks with Motley Fool contributor Rachel Warren about one of the most common errors people make when they invest: comparing themselves with others.
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Rachel Warren: Given your background and expertise in this area, what do you think are some of the most common psychological pitfalls that retail investors can fall prey to?
Dan Egan: One is that we are a herd-animal in ways that we might not suspect. One of my favorites is hearing about how other people are doing with their investments and the visibility that we have now. I'll actually make it even simpler. I actually have two friends who live somewhat close to each other. One of them has a really nice house that he keeps renovating. He drives two very nice cars, etc. He tends to dress very nicely. He looks like he has a lot of money because his money is put into things that you can see. The other friend drives an old busted Subaru, does a lot of the home repairs himself. That guy actually has a lot of money because he is not putting money into the things that you see. One of the things that's important to keep in mind is the asymmetry in what you see and hear from people's investment experiences versus what they actually do.
People tend to talk less about their failures when it comes to investing. But they'll be very proud of where they did well. They'll call out the specific investments where they did well. Meme stocks are a great example where, "I made a ton of money in GME [GameStop] or cryptocurrencies. I made a ton of money in Bitcoin." We tend to hear about the winners and over-weight them in our estimation of how other people are doing. Another is thinking about benchmarks and so on that aren't relevant. Am I beating, the S&P 500 or am I at least matching and tracking. If you have some a short-term goal like saving for a house down-payment down or sending your kids to college. It doesn't matter what the benchmark do. It doesn't matter with that external comparison is, all that matters is whether or not you are on track to do the thing that you want to do. How we think about and process information about how others are doing or how benchmarks are doing, we tend to over-weight it in allowing us -- in driving our decisions about how well we're doing, how well we feel about ourselves. We underestimate how much there is hidden successes out there, which is somebody didn't beat the market, but they totally sent their kids to college because they were saving enough to be able to do that. I think the more that you are socially focused in how your investments are doing, the more that it's about how you're doing relative to others, the more that you're actually probably not investing well.
