Investing columnist Jason Zweig on the big advantage small investors have over the pros

Published Thu, Feb 9 20171:15 PM ESTUpdated Thu, Feb 9 20171:49 PM EST

Jason Zweig, a best-selling author and investing columnist for The Wall Street Journal, sat down with CNBC's Mike Santoli for an in-depth discussion on the psychology of investing, the traits of successful investors and why the average investor is actually better off than the pros. "If you're an individual investor, you have a massive advantage over professional investors, which is nobody's looking over your shoulder, except maybe your spouse or your significant other or your partner," Zweig said. "And that cripples professional investors. And you don't have that cinder block tied to your ankles with a steel chain. You can judge your success by your own standards. And you can set your own time horizon. And I constantly urge people, think in terms of decades or generations rather than days or weeks or months or years," he added. Zweig is the author of "The Devil's Financial Dictionary," among other books, and edited the revised edition of Benjamin Graham's "The Intelligent Investor," the classic text that Warren Buffett has described as "by far the best book about investing ever written." In this exclusive interview, Zweig outlines the driving forces behind decision-making when it comes to money and investing and also discusses: Why smart people "turn stupid" when money is involved How investors can overcome counterproductive psychological quirks The future of active vs. passive investing Ben Graham's theories on value investing and whether they are still relevant PRO subscribers can also read the entire transcript of the exclusive interview below. (Editor's note: The content below is from a third-party service and there may be some minor transcription errors. Watch the video for the exact quotes.) MIKE SANTOLI: Jason Zweig is the investing and personal finance columnist for the Wall Street Journal. He's the author of The Devil's Financial Dictionary, a satirical glossary of Wall Street, and Your Money And Your Brain on the neuroscience of investing. So I the revised edition of Benjamin Graham's The Intelligent Investor, the classic text that Warren Buffet has described as by far the best book about investing ever written. He also assisted Nobel Prize winning psychologist Daniel Kahneman in writing his book, Thinking Fast And Slow. From 1995 through 2008, Zweig was a senior writer for Money Magazine. Before joining Money, he was the mutual funds editor at Forbes. And he joins us here at the Nasdaq to talk about his approach and his outlook on investing. JASON ZWEIG: Great to be with you, Mike. MIKE SANTOLI: So we just ran through the stops along the way of your career. And it occurs to me, you were writing about mutual funds, about investing in the '80s and '90s. The dominant tone over those years, as I recall it, being there, as well, was about the star manager of funds, or the hot stock that you might want to get your hands on. How did you make your way through that and to this focus on how our minds are structured as investors and the pitfalls of the psychology of investing? JASON ZWEIG: I guess part of it is just observing and trying to learn from my own mistakes. I think, like just about every investor, individual or professional alike, I went through a phase where I was a performance chaser. I bought some stocks. I bought a bunch of funds whose managers were really hot. Maybe this comes from growing up on a farm or something. I don't know. But I hated to bury my mistakes. I wanted to try to learn from them. And by the mid '90s, it had started to dawn on me that performance in the financial markets is really perishable. Even 20 years ago, it was like unrefrigerated sushi. In a matter of moments, it seemed, it was gone. And so I was just trying to learn from that. And the central question that I settled on is, "Why do smart people turn stupid when money is involved?" And I'm not sure I still have all the answers. But I think that's the question to focus on. MIKE SANTOLI: Now, is it the fact that, after all the work you've done on this, that smart people turn stupid in the presence of money or when it comes to investing, or do we behave in these ways in every kind of pursuit and maybe the stakes are higher with investing? Or is there something about investing that does set off those triggers that aren't so productive? JASON ZWEIG: Yeah. I think what a neuroscientist would say is that smart people, in the presence of risk and reward, do stupid things or things that seem stupid by contrast. We wouldn't expect a sort of naive or maybe foolish person to make good decisions when they're thinking about risks and rewards. But you would expect a smart person to. People with graduate degrees. People with Wall Street experience. But in fact, many professional investors are at least as prone to these basic cognitive biases as the most naive individual. And I think it's because the brain really evolved to make very simple decisions about what will pay off and what could hurt us. And those very primal reactions in the brain can really interfere with your higher thinking at times when you really would like to rely on that. MIKE SANTOLI: What are, then, the small number of these elemental traits that people have that we should try to be mindful of, that we should strive to maybe work against or try to find ways to mitigate? JASON ZWEIG: I think the first is probably overconfidence. Everybody loves to tell an evolutionary fairy tale. But if you just imagine our ancestors on the planes of the Serengeti a couple million years ago, when a band of early humans were looking for food, the one who could first identity where the payoff was likely to be, who was confident about the outcome, would obviously become the leader. On the other hand, the one who mistakenly identified something that turned out not to be a reward but a punishment would end up extinct. And so that quick, confident selection of a reward really became encoded in our genes. It's very hard for people to fight. So that's a first. I think, also, fear of loss, which is the flipside of that, is incredibly powerful. Psychologists call it loss aversion. It's been shown at a very basic level in the brain. And then I think the third is the almost electrical excitement you get from winning and then winning and then winning again. It can become almost impossible to let go. MIKE SANTOLI: And I know you've pointed this out. But the research has shown that it seems to be the anticipation of a payoff that is more powerful, in a sense, than actually attaining it. JASON ZWEIG: Yeah. Absolutely. MIKE SANTOLI: In a way, if you think about it, that's tough to break as a behavior, right? Because even if you haven't gotten the payoff, you still like that anticipation. JASON ZWEIG: I participated years ago in an experiment at Stanford University that was absolutely fascinating, where, when I was shown the prospect of winning a small amount of money, I think it was $5, my brain was just going, "Ka-ching, ka-ching, ka-ching." Like a one-armed bandit on the floor of a casino. And when I actually received the money, there was almost no response. And if you think about what happens in the stock market every day, when people think a positive earnings surprise is coming, they drive up the price of the stock. Then the company beats the forecast. But if it doesn't exceed what people were expecting, the stock either does nothing, or in some cases, it even goes down. And that's the product of that basic dopamine loop in the brain. MIKE SANTOLI: When it comes to actually putting into practice principles that just make sense to try and balance out these tendencies, personal finance writers, I have always thought, have done a great job. It reminds me of people who write about health and nutrition. It's kind of the basic stuff. You just have to always focus on it. But behaviorally, it's hard to stick to a certain kind of plan. So if you're talking about low fees, diversification, essentially not chasing the hot thing, have we gotten, in aggregate, better at those things? In other words, are we smarter at all in, let's say, the last 20 years in how we go about these things? JASON ZWEIG: I think so. A little bit. Mike, I'm sure you've heard him say it, too. Warren Buffet has this wonderful expression where he says, "Investing is simple, but it isn't easy." And the analogy you just made to diet is perfect. Anyone who's the least but overweight knows exactly what to do about it. Two things, right? Eat less, exercise more. Couldn't be simpler than that. But it isn't easy, because we live in a world full of chocolate cake and TV shows we want to watch while we're stretched out on a couch. And the financial markets function much the same way, where there are really simple, beneficial behaviors that have been proven for decades, maybe even centuries, to work really well. But we've got all these flashing bells and all kinds of sensory information coming at us prompting us to do things that maybe aren't as good for us. MIKE SANTOLI: I think in particular about the way that there is now much more of a focus on the fees that you pay for somebody to manage your money. It wasn't really all that long ago when it would seem like this secondary, tertiary concern about exactly what an expense ratio of a fund was. Hey, the market's going up 15% a year. This guy is going to make me 20%. I don't care if I'm paying 1.5%. Now, though, you have everybody flocking in large numbers to low-cost index funds. Now, who knows if that's the evaluation people are making. But it seems as if perhaps people have gotten that hint? JASON ZWEIG: I think so. There's one thing that it's important not to overlook, which is that it's not so much that overall costs in the system to investors have fallen. It's that they've shifted. There was a time when you would pay, say, 1-2% in annual management fees to a mutual fund. And maybe you would pay 5% up front to the broker who sold it to you. You own the fund for ten years. You've amortized your costs to maybe 2% a year on average. Very rough math. Today what's happened is the costs of the funds have shrunk, in some cases, very close to zero if you use the ETFs. But the cost of the financial advice has not fallen. In fact, in some cases, you could argue it's gone up because now, instead of paying one time up front, you're paying every year. And the meter is just always running. And so people have changed what they're paying for. But the price they're paying hasn't come down nearly as much as it seems and, I would argue, nearly as much as it needs to. MIKE SANTOLI: There's this interesting debate, as you know. People who have an interest in trying to make it seem as if they should be paid to try to beat the benchmarks are saying that it's possible for the pendulum to swing too far in the direction of passive index funds. And they're, of course, saying it's happened recently. Do you even think, conceptually, it's possible for that to be the case? I know Jack Bogle at Vanguard has tried to make the case, if you just have a couple of people trying to beat the market, the rest of us can take advantage of that. JASON ZWEIG: Yes. I think there is an outer bound. There's a point at which the lines cross and the financial markets won't function properly if too many people are investing exclusively through index funds. The problem I have is that nobody seems to know where that point is. And more interestingly, there doesn't even seem to be a theory that would tell us how to estimate where that point is. I've spoken to at least five Nobel laureates in economics about this, and the heads of all kinds of active investing firms and passive investing firms. And nobody pretends to know. Some people say two thirds would have to index. Some people say 95%. But when you ask them, "How do you arrive at the number?" They can't tell you. So, sure. If 99.99999% of all investors indexed, that probably would lead to a market break down. And the number where markets kind of freeze up is probably below that. But I don't know where it is. MIKE SANTOLI: And wherever we are, 35-40%, probably less. JASON ZWEIG: We're at most in the low 30s. And the other thing to bear in mind is that's index funds as a percentage of assets. If you look at index funds as a percentage of trading volume, it's way smaller. So the marginal price setter in trades of individual securities is still on the active manager. So I would think we have years to go before this becomes an issue. The other thing is, if I were an active investment manager, I would be looking forward to that rather than portraying it as some kind of Armageddon. Because that should be the day that your horse comes in. If you're the one who somehow knows how to identify value when index funds can't, then when they dominate the market to a dangerous extent, you're gonna make more money than ever. MIKE SANTOLI: Sure. We mentioned your role in editing the new version of Benjamin Graham's book. What is his relevance or his thinking's relevance right now, today? People would look back and say, "Look, it's hard to even invest that way anymore, find these companies that are so deeply undervalued." But what's the take away for today? JASON ZWEIG: I think there's two things to think about. The first is that a lot of Graham's principles are difficult to apply in a market where, because of low interest rates and central bank intervention and a lot of other factors, valuations are very high. Graham is tailor-made for markets like the wake of the Great Depression, the 1960s and '70s, 2008-2009, when a lot of stocks get marked down to bargain levels in a hurry. So it's important to know how to do it because, believe me, that time will come, and it is coming, I just don't know when. But I think the other component of Graham's thinking that is always relevant and never will go out of style is the vital importance for investors of doing your own thinking. Remembering that the market is this manic depressive weirdo who creates prices in the end of 1999 and the beginning of 2000 that are literally insane. And everybody says, "Okay, sure, whatever." MIKE SANTOLI: You have to make up a story to justify, somehow. JASON ZWEIG: Right. And then, of course, Nasdaq goes down whatever it was. MIKE SANTOLI: Eighty percent. JASON ZWEIG: Eighty-five percent in 11 months, or something like that, because it was wildly overvalued. So you get the manic phase, and then you also get the depressive phase, like the fourth quarter of 2008 or the first quarter of 2009. And what Graham teaches is, you're you. You don't have to let Mr. Market tell you how to feel about stock values. And in fact, to the extent that you do, you should let him tell you how not to feel. So if he's manic, you should tilt towards depressive. And if he's depressive, you should get excited. And this brings us back to Buffet's famous observation that we should be greedy when other people are fearful and fearful when they're greedy. MIKE SANTOLI: And just to knit it back to today, you wrote recently, as the Dow it 20,000, maybe it's time to be more cautious than celebratory about that moment. Because of high valuations, because expected returns don't look great? Is that why? JASON ZWEIG: Yeah. Look, market milestones really are just milestones. And there's no real economic significance to Dow 20,000 or any other market level on any benchmark. But if, as an investor, you can use it to introspect and say to yourself, "Am I pleased that the market just set a new record high?" What does that tell me about me? Why would I be happy about that? Sure, my account values are up. But what does that say about my future returns? And if you think about it logically and objectively, we're nine years, roughly, into a bull market. We've had monster returns. It is a time to be cautious. And if a milestone can lead you to think about how much farther the race has to run, then that's a useful function for it. MIKE SANTOLI: And in fact, if you take it a step further, and people do decide, "Well, maybe the market is not gonna really deliver that great a return in forward years," your conclusion might be, "Well, maybe I have to save a little bit more," right? So it's not always get out of the market. It's just adjust your behavior to account for that. JASON ZWEIG: I think that's hugely important. Even when I speak to institutional investors, investment committees and chief investment officers at big firms or endowments, what a lot of people say is, "We need higher returns, so we have to take more risk." And the market doesn't care what rate of return you need. It doesn't know what stocks you own and it's not going to generate a higher return because you need it. If you want more money down the road, you're going to have to save more and set more money aside. And you might be able to get a slightly higher return by taking a little more risk. But you could also get wiped out, and that's what the extra savings are really for, to help bolster you against that. MIKE SANTOLI: Finally, the other piece that I think doesn't get a lot of attention is, as an individual investor, if you're not a professional being judged by how your portfolio does against a benchmark, you have the ability to allow the market to keep going up without you and not have much of a cost for that. JASON ZWEIG: The single most important question any investor can ask, no matter whether you're the smallest individual investor or the most powerful hedge fund manager is, "What is my edge? What do I bring to this that the other hundred million American investors don't bring?" And if you're an individual investor, you have a massive advantage over professional investors, which is nobody's looking over your shoulder, except maybe your spouse or your significant other or your partner. And that cripples professional investors. And you don't have that cinder block tied to your ankles with a steel chain. You can judge your success by your own standards. And you can set your own time horizon. And I constantly urge people, think in terms of decades or generations rather than days or weeks or months or years. MIKE SANTOLI: It's a great luxury. Jason, thank you very much. JASON ZWEIG: Great to be with you, Mike. Thank you. MIKE SANTOLI: For CNBC Pro Talks, I'm Mike Santoli. Transcript by Transcript Associates, Inc.

"If you're an individual investor, you have a massive advantage over professional investors, which is nobody's looking over your shoulder, except maybe your spouse or your significant other or your partner," Zweig said.

"And that cripples professional investors. And you don't have that cinder block tied to your ankles with a steel chain. You can judge your success by your own standards. And you can set your own time horizon. And I constantly urge people, think in terms of decades or generations rather than days or weeks or months or years," he added.

Zweig is the author of "The Devil's Financial Dictionary," among other books, and edited the revised edition of Benjamin Graham's "The Intelligent Investor," the classic text that Warren Buffett has described as "by far the best book about investing ever written."

In this exclusive interview, Zweig outlines the driving forces behind decision-making when it comes to money and investing and also discusses:

Why smart people "turn stupid" when money is involved
How investors can overcome counterproductive psychological quirks
The future of active vs. passive investing
Ben Graham's theories on value investing and whether they are still relevant

PRO subscribers can also read the entire transcript of the exclusive interview below.