The Fear Factor

It’s a Saturday afternoon in late August, and I am once again staring intently at the Find My app on my phone. I’m watching the grey circle that is my oldest child moving steadily further and further away. This year, he’s got a car, and we all agreed that the best solution to the usual back-to-school calendar snarl was for him to drive to college in Montana from Minnesota on his own.

Why am I staring at the grey circle, now 600 miles away? Because I am filled with fear that something terrible will happen to him out there on the road. I have this irrational idea that if I see the dot stop moving, I will spring into action and bring resources to bear to ensure he’s safe. My intellectual brain knows that 1) the probability he is killed on the road in his entire lifetime is less than 1% and 2) me staring at Find My will absolutely not prevent a statistically rare bad outcome from occurring. In fact, it’s making me much less functional today and serves no purpose! But my animal brain will not put the phone down – fear is making my decisions today.

Here's something you may not know about me: I’m always afraid, every day, all day. I fear so many things! Let me rattle off the ones that come to the surface most immediately:

·?????? Something horrible happening to my kids

·?????? Something horrible happening to my partner

·?????? Messing up the podcast I’m on today

·?????? Running out of money

·?????? Poor absolute returns at the Foundation for a multi-year period

·?????? Skipping meet the teacher night for the 5th year in a row

·?????? Disappointing my colleagues or board or investment committees

·?????? Missing my flight home tomorrow morning

·?????? Being a bad manager of my team

·?????? Not getting enough exercise today

·?????? Becoming unable to work

·?????? Forgetting to sign that field trip form…

The list of things I’m afraid of is endless. It includes existential fears and fears related to more immediate events, fears that are clearly warranted and fears that are not all that important. And all of these fears make up my drive, my energy, my insistence on persisting.

Fear fascinates me. From the National Library of Medicine (paraphrased):

First and foremost, fear is a functional definition: fear is a central state of an organism. It is not identified with the conscious feeling of being afraid, nor with fear behaviors such as screaming and running away. Both feelings and behavior can of course be used as evidence for a central state of fear, but the evidence for the state is not the state itself.

Instead, fear as a central state is what causes the conscious experience and what causes the fear behaviors. Fear in turn is caused by particular sets of stimuli. Fear is what links sets of stimuli to patterns of behaviors. Unlike with reflexes, this link in the case of an emotion like fear is much more flexible and the state can exist prior to and after the eliciting stimuli.

Humans are alive today because fear is a central state of being. Fear is a natural biological condition that keeps us safe. Most of us are born with two innate fears: fear of falling and fear of loud sounds. Then, over centuries, we’ve developed learned fears due to interactions in the world that taught our ancestors critical differences between threatening and non-threatening stimuli.

Fear plays an important role in workplace culture as well. Much of the investment industry has utilized a fear-based employment structure. Here are a few signs typical to a fear-based work culture:

·?????? Employees cannot leave the office until their boss exits

·?????? Preoccupation with status and individual political capital

·?????? Intense competition between employees

·?????? Obsessive attention to employee metrics

·?????? Hoarding of information

Sounds pretty familiar, right? I pulled that list from an NBC news article on toxic workplaces and just basically described what it’s like to work in investment banking! I’d bet quite a few of you readers got your start at one of the I-banks. And as the farm-team for the rest of the industry, it’s easy to see how early experiences in a fear-based workplace culture have been exported to so many additional investment firms. Throw in factors like being young and female, and it makes a lot of sense that I was so afraid of setting boundaries or asking for help for much of my career.

Fear plays an outsized role not only in industry culture, but also in investment decision-making. Top of the list: loss aversion bias. Over the course of my career, I’ve found loss aversion to be particularly acute in two groups of investors: individuals and pension plan CIOs.

From behavioraleconomics.com:

“Loss aversion is an important concept associated with prospect theory and is encapsulated in the expression ‘“losses loom larger than gains’” (Kahneman & Tversky, 1979). It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining.”

Let’s tackle individuals first. This great retirement plan study from John Hancock neatly encapsulates much of the story. The 2022 study covers the 1.6 million participants on their platform, with a total of $108.5 billion in assets. 84% of investors under the age of 30 held less than the recommended amount of stocks, and 55% of investors in the 40-49 age range were also underweight equities. Only 20% of participants in the Hancock retirement plans were investing within the recommended allocations for their age groups. Individuals’ desire to avoid losses leads to overly conservative retirement portfolios that will miss out on long-term return compounding – which is absolutely going to harm their income in their later years.

Another critical lesson in fear-based investment decision-making comes out of the 2008-2009 financial crisis. Per Fidelity, 117,000 people on their platform sold ALL of their equity holdings between October 2008 and March of 2009. These are the people who looked at the losses and tragically panicked, and very likely never recovered their portfolio value. As of June 30th, 2011, half of these folks had not reinvested, fully missing the 66% gain in the S&P 500 over the same timeframe.

Next up: pension fund CIOs. I’ve spent a lot of time on conference panels and in private conversations with pension fund leaders and let me tell you: they are basically terrified 100% of the time. These poor folks are trapped between public officials trying to maintain elected positions and external consultants trying to increase fee revenue. Your elected officials can turn on a dime and bash you for political expediency, while your consultants are feeding you a steady diet of gigantic funds with declining return streams. This structure makes it nearly impossible to get compensation and staffing to attract talent and take the kind of risks necessary to produce great returns. Add in the fact that all your meetings are livestreamed, and it makes total sense to hide under a rock and just hope to survive the gig. The result is a very concerning downward trend in pension fund returns over the last 20 years.

Fear of missing out is yet another facet of both life and investing. Sort of on the flip side of loss aversion, FOMO in investing generally manifests as irrational investing behavior wherein herds of folks experiencing regret aversion all pile into the same trade. We all had a front row seat to the FOMO show in 2021 with the Reddit-fueled GameStop mania and the crazy run-up in crypto-related assets in early 2022, both of which we touched on in this newsletter, The Wisdom of Crowds. Guys, remember when Matt Damon told us that “fortune favors the brave"? I wonder what he got paid for that ad...

I guess I missed out on the whole FTX debacle because I was too filled with fear of investing the Foundation’s money in an unregulated entity based in a jurisdiction favored by fraudsters, seemingly accountable to no one. ?

The investing industry is so susceptible to both loss avoidance fears and fear of missing out that we have an index devoted solely to monitoring these vibes! The Fear & Greed Index was developed by CNN Business to measure investor sentiment. The index is calculated daily and is based on the logic that excessive fear will drive share prices down, and too much greed (read: FOMO) will drive prices up. Team Fear appears to be winning for now.

Here's the thing about fear: you have to respect it, but you still gotta be able to function. If I’m perpetually in a state of panic, I’m going to make mistakes, miss critical information signals, and probably crash the car I’m driving. The obsessive version of fear is the main cause of analysis paralysis, which is also not a great state of mind for investors. I’m not really a basketball stan, but NBA coach Gregg Popovich’s term “appropriate fear” has always resonated with me. “Appropriate fear” is neither the panic nor the obsessive response to your fears. It instead is more that you have a degree of skepticism about your own abilities, and are appropriately afraid of your opponent’s abilities, such that you do not underestimate him in the game.

Appropriate fear in investing means planning for the more probable scenarios, designing a portfolio that manages sufficient returns and cash flows within those scenarios, and incorporating a few approaches that can hedge against a handful of the edge case scenarios. Hmmm…wait a minute. If this sounds suspiciously like the language we use in designing our strategic asset allocations, that’s because it is! The strategic allocation is bumper bowling for institutional investors: all of our fears about our skills, our teams, the limits of capital markets assumptions, black swan events and governance snafus are rendered down into tidy asset class and subclass targets and ranges. You do still have to hit the pins with the bowling ball, which is why we all have benchmarks, but the bumpers improve the probability of success. I can (and will) argue about the utility of some of the results of the SAA process, but here’s the thing: it manages the investing fears into a format that allows us all to function.

It has taken me the better part of the last 15 years to get more comfortable naming my fears. I make time for sitting with them, turning them over, dumping them out, and reshaping them. Those of you who have seen me on a stage may be surprised to know that I find public speaking terrifying. I get to a place of comfort before each gig by acknowledging and talking with myself about my fears. This puts them a bit further away from my animal brain.?They are all still very much alive and well but this mental distance I’ve created means that specific fear doesn’t have to dominate my intellectual brain, my decision-making process, or my ability to interact with others. Fear is ever present. Most days I can keep it from chasing me the way it is today, as I’m irrationally watching that little grey dot that is my first child, driving across the country on his own.

What are you afraid of, readers? What strategies do you use to you get yourself to a place of “appropriate fear”? How do you balance the motivation and preservation benefits of fear without allowing it to short-circuit your decision-making process?

And yes, he made it safely.? ??