Of Faith and Finance

Researchers believe that the reason for the behavior gap is that investors quite literally lose faith in their portfolios at the wrong times. They later gain conviction in the market at the wrong time. Instead of “buy low, sell high,” investors too often do something close to the opposite. They sell out of despair and buy out confidence in a trend that may be half-way (or more) to running its course already.

My perspective on closing this gap comes from the people I’ve worked with. When I interview clients about why they abandoned their strategy in the past at the wrong times, I was surprised at first when I would hear that they hadn’t understood or believed in their portfolios in the first place!

Much of the time, they didn’t understand what they were getting in to at first, and only really started taking a hard look at their portfolio when it was losing money. For some, it made it easier to give up on their investments when times were hard when they realized what they had was never what they wanted.

As an advisor, what I want is for investors to believe in their portfolios from the beginning. A large part of that is the advisor’s responsibility: helping investors understand what they’re invested in mitigates the risk that investors will only come to realize what they’re invested in when it’s under water.

Another part of that is helping investors avoid what they think is a bad idea from the start. If gambling is something that seems self-destructive and toxic to an investor, what will that investor do when they see that their casino-related investment is losing money? There’s a risk they’ll tell themselves that they knew the investment was a loser from the start, and they’ll sell it when it makes the least sense to sell. In fact, we have a name for that behavior, and it happens to one of the most powerful forces in decision making: confirmation bias.

Tradition says that a man came to the great Rabbi Hillel and demanded the sage teach him the entire Torah (the first 5 books of the Hebrew Bible) while standing on one leg. Hillel obliged, saying: “That which is hateful unto you do not do to your neighbor. This is the whole of the Torah, The rest is commentary. Go forth and study.”

I’d say something similar about investing as an investor of strong conscience: That which is hateful unto you, do not put in your portfolio. You’ll regret it most when you need the most conviction in it.

To me, the most convincing argument for investing with ethical conviction is that once you have an investment you aren’t offended by, you will be able to think more rationally about it for what it is- a money-making proposition. The thing about the behavior gap is that it shows how irrational buying and selling patterns are at large. Reducing the barriers to reasonable thinking as an investor reduces one of the most persistent risks that investors consistently face.

What we’ve looked at so far is how bias against our own portfolios harms us as investors. Now that we’ve seen how ethics plays a part in closing the behavior gap, let’s tie faith more explicitly into the equation.

For many people of all religions, religious creeds are the primary or sole source of ethics. They provide the lens through which ethical questions are looked at. How can something so meaningful to one’s thought process not have bearing in investment selection?

With that said, it’s up to each individual investor to determine how large a role their faith plays in their system of ethics. It’s worth examining before considering making any big changes in portfolio composition- for some, morality may come from politics or secular philosophies primarily, even as a person of faith. This is not to say that everyone needs to know all of the answers to life’s tough moral questions before buying a Mutual Fund. What really matters here is avoiding investments that you might question later.

Let’s look at a couple of real-world questions that can put investor’s convictions about the soundness of their strategy in question during hard times:

Biotech is a major growth avenue in the 21st century. Emerging treatments for once fatal diagnoses are being pursued with ever-increasing amounts of capital, and some of those solutions have rewarded investors handsomely. That doesn’t mean it’s right for everyone. Let’s take the example of a middle-aged Christian family that strongly objects to research practices used by many biotech firms. I’d much rather that they pursue investments that profit from this sector that don’t violate their beliefs, in part because I’d hate to hear too late that they knew these investments were no good all along at the depths of a losing streak for this notoriously volatile sector.

Some investors believe that “vice” related investments (alcohol, tobacco, gambling, etc.) thrive during dark times for the broader economy. For a young Muslim family, that may be a trend they cannot profit from in good conscience. It may distress them all the more to know their returns are swelling with the demoralization of the economy at large.

For a Jewish investor, loans with staggering interest rates may violate ethical standards even as these loans thrive in the midst of falling credit quality across the board. I’d much rather find bonds that produce enough income than cross that ethical line. After all, modern markets provide so many investment choices, there’s rarely a reason pit one’s portfolio against one’s faith.