What a Simple Coin Toss Exercise Can Teach Us About Investing

Coin Toss and Investing

At a recent conference the presenter led a group of financial advisors through a coin toss.

“I am going to flip this coin five times, each time I want you to predict heads or tails – you don’t need to call out – just remember your prediction.  Ready?” the enthusiastic young presenter said as he gazed out into an auditorium full of financial advisors. 

There were mummers of “uh-huh”, “yes,” and a few nodding heads.  Financial advisors, the presenter knew, do not readily embrace audience participation. 

“OK,” he marched on.  “Here is the first toss.” Fifty advisors silently watched the coin rise from his left hand and return to his right.

“Heads!” he called.  The advisors were not impressed.

“OK, toss two.  While the coin is in the air make your predictions.” Again, the advisors watched expressionless.

“Heads!” he called out.  “OK, we have heads and heads.  Next toss.  Ready for toss three?  Here we go.” A few advisors actually leaned forward in anticipation as they watched the coin rise and fall. 

“Tails!  We have heads, heads, and tails. Now this is toss four. Ready?” This time more advisors leaned forward as the coin rose and fell.

“Tails!  OK, we have heads, heads, tails, and …”

“Tails,” several advisors volunteered to their own astonishment.

“Right.  OK, last toss.” By now the whole room was engaged.

“Heads.  OK, heads, heads, tails, tails, heads.”

The presenter smiled at the crowd. “Did you find yourself looking for pattern as you made your prediction?” Many advisors nodded embarrassingly.  Some even raised their hands. 

“What difference did the prior toss have on the outcome of the next toss?”

“Zero!  None!” came the shouts from a few advisors.  They knew the answer to that one!

Right.  Each toss is independent has no effect on the outcome of the next. 

There is a 50/50 chance of heads or tails on each toss.  But, the presenter noted, our brain looks for patterns. Even though we know each toss is independent we look for patterns.  We had two heads in a row, so there are two thought patterns:

  • We are on a roll, pick heads, or
  • We are due for a change, pick tails.

The presenter went on to explain that we create “anchors” (past performance) and our perceptions are created by past experience (performance) and current beliefs (“We are on a roll.”).

Is it any wonder investors do the same thing in the stock market?  Many investors try to determine if the market will go up or down.  We all laugh at the obvious, “Past performance is not an indicator of future returns.”  But, after a nine-year bull market, many investors have been shocked that volatility has returned and the stock prices have gone down. 

The point is not that we can overcome bias, it is that we should be aware of them.  Are you, as an investor, aware of your anchors and biases and able to manage them?  Many investors chose advisors for that reason, to provide objectivity and proactivity in investing.

If you're looking for objective, proactive guidance regarding your wealth management strategy, give us a call at 410-715-9200 or email me, Mark Stinson, at mstinson@faiwealth.com.

About FAI Wealth Management, Inc.: Located in Columbia, Maryland, FAI focuses on helping clients create the financial future they desire by protecting their wealth, making the most of their assets, and planning for life's uncertainties. The firm combines fee-only, fiduciary-driven guidance with highly personalized, consultative financial planning and investment services that enable individuals, families, and businesses to navigate complex life transitions. Founded in 1987, FAI currently manages more than $350 million in client assets nationwide. For more information about FAI Wealth Management, please visit the website at https://www.faiwealth.com or call 410.715.9200.

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