Investment Lessons From Your Thanksgiving Turkey

Thanksgiving is an appropriate time to be thankful for the rich bounty that stocks have given us this year, but it is also a crucial time to consider the “turkey problem” as it relates to investing. Nassim Taleb introduced the world to the “Black Swan” and used this tale to illustrate the concept. Imagine the life of a turkey where a kind farmer feeds and tends to it every day until suddenly, on the day before Thanksgiving; the situation takes an irrevocable turn for the worse. The turkey has only observed a positive trend during its lifetime up until that fateful Wednesday. The turkey is at its fattest and happiest at a point that turns out to be the time of maximum risk. Investors must beware when the trends look obvious and making money seems effortless: “The same hand that feeds you can be the one that wrings your neck.”

This “turkey problem” illustrates the automatic human response in expecting trends to continue, as we all have a built-in tendency to see patterns even when they do not exist. According to Jason Zweig in Your Money & Your Brain, this propensity to look for patterns is part of our evolutionary survival mechanism since our primitive brains were tuned to the immutable physical laws of nature, like when lightning strikes, thunder follows. In addition, humans also suffer from “recency bias.” In other words, we weigh recent experiences more heavily when predicting future outcomes. These biases are why people expect stocks to continue to rise if they have increased recently. Indeed, there is convincing evidence of momentum in stock returns, but this is not an unfailing natural law. Instead, this tendency for stocks to continue to perform well does not always work, and the signal tends to erode and eventually reverse. Investors using price momentum would be wise to have a systematic process to implement the strategy across a portfolio of stocks with a strict sell discipline. Stocks and the financial markets do not follow the rules of nature, so our trend-seeking behavior can often lead us to make poor choices.