Margaret Heffernan, in her wonderful book Willful Blindness, provides insights that can help explain why many investors and advisors continue to use active strategies, not only in the face of all the evidence, but also despite the evidence of their own failures in the quest for alpha.
Willful blindness is a legal concept -- you can be held responsible even if you weren't aware, but could and should have been known something was wrong and decided not to see it. The claim of not knowing isn't a sufficient defense. Heffernan notes: "The law doesn't care why you remain ignorant, only that you do." Corporate executives greedy for compensation, politicians who vote for legislation knowing it will never work and auditors who turn blind eyes to findings because they don't want to lose their client's business all make destructive blunders because of willful blindness.
The following are some of Heffernan's observations:
- We mostly admit the information that makes us feel great about ourselves, while conveniently filtering whatever unsettles our fragile egos and most vital beliefs.
- Love is blind, what's less obvious is just how much evidence it can ignore.
- Our most cherished beliefs are a vital and central part of who we are -- in our own eyes and the eyes of our friends and colleagues ... A challenge to our big ideas feels life-threatening. And so we strive mightily to reduce the pain, either by ignoring the evidence that proves we are wrong, or by reinterpreting evidence to support us.
Confirmation bias contributes to the problem of willful blindness. Heffernan notes that "people are about twice as likely to seek information that supports their own point of view as they are to consider an opposing idea." They're particularly "resistant to changing what they know how to do, what they have expertise in and certainly what they have economic investment in."
Noted economist Paul Samuelson would probably agree with Heffernan, based on his insight: "[A] respect for evidence compels me to incline toward the hypothesis that most portfolio decision makers should go out of business -- take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed. Few people will commit suicide without a push."
Another problem I have frequently observed is that no one likes to be told they've been doing something wrong all their lives. To address this problem, I point out that I used to be an active investor. However, I did what all smart people do when they learn they're mistaken -- they don't repeat the mistake because doing so would be what Einstein said was the definition of insanity: Doing the same thing over and over again and expecting a different outcome.
Being willfully blind can have disastrous consequences, as Jeffrey Skilling and Kenneth Lay, the former CEO and Chairman of Enron, found out. And the financial crisis could have been avoided if politicians, regulators and corporate executives weren't willfully blind to the dangers staring them all the face. The evidence was all there, but many of them chose not to know. And it can be equally destructive to be willfully blind to the overwhelming body of evidence demonstrating that passive investing is the strategy most likely to allow you to achieve your financial goals. I have seen this happen all too often.
As Heffernan notes: "While willful blindness may be part of the human condition, it need not define who we are." You don't have to go through life blind. If you're an advisor, you don't want to continue to collude with Wall Street. (Many advisors I have met have been concerned that if they choose to use passive strategies their clients won't think their fees are justified. Thus, they stick with an active strategy despite knowing it isn't in their clients' interests.)
If you're an investor, now that you're aware of the concept of "willful blindness" you should be attuned to its dangers. While old habits die hard, they can be overcome. Smart people make mistakes, but having learned they are mistakes they change their behavior.
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