Eyeworld

22 Ophthalmology Business • March 2016 many of us would lose confidence in the machine, becoming reluctant to use it again in a similar situation. It seems that the errors that we tolerate in humans become less tolerable when machines make them." Simply put, we're less apt to trust a system of rules than our own instincts or those of another human. This is problematic because, as I pointed out earlier, emotionless, rules-based in- vestment strategies have been proven to outperform most human investors. Even the S&P 500's simplistic strategy of owning large cap U.S. stocks outper- forms, mostly because it just plays by the rules. Trusting a rules-based strategy isn't always going to be easy, but in the long run you'll likely be very happy you stuck with it. OB Reference 1. Dietvorst BJ, et al. Algorithm aversion: people erroneously avoid algorithms after seeing them err. J Exp Psychol Gen. 2015 Feb;144(1):114– 26. In more than 25 years in the in- vestment business, I've seen study after study that supports the fact that rules- based, statistically driven models typ- ically outperform humans. But when underperformance or market volatility rears its ugly head, our brains tell us to ditch. The strategy is broken. Why is it that investors don't trust a rules-based strategy? This phenomenon has been dubbed "algorithm aversion" in an excellent research paper titled, "Algorithm aversion: people erroneously avoid algorithms after seeing them err" pub- lished by the American Psychological Association. The paper states that, despite proven research that demonstrates the superiority of evidence-based algo- rithms to human forecasters, people continue to show more willingness to trust an emotional human being over a set of emotionless rules. Here's an ex- cellent example of this behavior from the paper: "Imagine that you are driving to work via your normal route. You run into traffic and you predict that a different route will be faster. You get to work 20 minutes later than usual, and you learn from a co-worker that your decision to abandon your route was costly; the traffic was not as bad as it seemed. Many of us have made mistakes like this one, and most would shrug it off. Very few people would decide to never again trust their own judgment in such situations. Now imagine the same scenario, but instead of you having wrongly decided to abandon your route, your traffic-sen- sitive GPS made the error. Upon learning that the GPS made a mistake, it's nearly impossible to stick with a strategy during a period of underper- formance or volatility. You should know that ditching your game plan when times get tough is a recipe for disaster. You may as well not even have a strategy at all. Unfor- tunately, that's what people do when the market starts pulling back. The 2015 DALBAR Quantitative Analysis of Investor Behavior report supports this premise. The report states that for the last 20 years the average investor has earned annualized returns just north of 5% (5.19% to be exact). Over the same time period the Stan- dard and Poor's 500 Index (S&P 500) returned 9.85%. So the S&P 500 has earned an annualized return of almost 10% while the average investor took home about half that amount. Why the big gap between investors and the index? The main reason the S&P 500 is able to outperform the average investor is because that index doesn't have any emotions. It's just an index. It doesn't read the newspaper or watch the pun- dits on television. The whole idea with the S&P 500 is it buys the 500 largest publicly traded companies in the U.S. and weighs them according to their market capitalization. It's a very simple strategy. It makes changes when it's appropriate to make changes. It doesn't say, "The market is in trouble. Time to ditch." That's not how the S&P's strategy works. It doesn't deviate from its strategy based on market conditions. These are its rules and it must abide by them. We should all take a page out of its book and become just as loyal to our own investment strategies. Mr. Balser is the managing partner and chief investment officer of Balser Wealth Management, Avon, Ohio. He works one on one with in- dividuals to reduce risk in their investment and retirement portfolios to ensure they will not run out of income in retirement. He can be contacted at roger@balserwealth. com. continued from page 21

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