Bryan Caplan thinks that portfolios don’t reveal much about actual beliefs,. Here is one of his arguments:
Even prominent Nobel prize-winning economists admit they follow simple rules of thumb when they invest. So unless people’s beliefs are carved in stone, how could portfolios possibly reveal much about their beliefs? Tyler is a case in point: He changes his mind a hundred times a day, but he follows a simple financial strategy that hasn’t varied in years.
I view it differently. I don’t trade in public markets but I vary my allocations by changing how much money I spend and how to allocate my time. Perhaps not coincidentally, this puts me square into the world of classical finance theory as represented by “the mutual fund theorem,” with a static equity portfolio of fixed proportions and some unique covariances on my human capital. I call that rationality not inertia.
Bryan, you will note, is a founder of the theory of rational irrationality, which suggests you become more rational as the private stakes from your decisions go up. These days he is wishing to argue that the truly small stakes reflect what you really think, through the lens of mental accounting and compartmentalization. Of course that would undercut or at least drastically relativize his earlier theory. I say he has made a large and successful career bet — much bigger than any of his piddly ante monetary bets — on the theory of rational irrationality, so he must really agree with me after all.
It also happens that Bryan’s emphasis on simple rules of thumb will work against his interest in person-to-person bets as a metric of authenticity. If you don’t change or examine your overall portfolio very often, that means some reasonably wide range of portfolios is a matter of indifference or near indifference to you, if only because fine-tuned improvements are hard to find. (Do you really give matters a re-ponder when a firm in your portfolio pays dividends?) In that case, however, the small bets won’t be authentic either. One could compartmentalize one’s personal bets quite easily and say to oneself — whether consciously or not — “I can make this small bet: it still keeps my overall portfolio within that broad range of indifference.” Which indeed it does. The bet is then undertaken for expressive reasons, which is fine, nothing against that, but for me it is more fun to cheer for Tony Parker (without betting on him). I think of these small personal bets as akin to sports loyalties most of all and not as a unique window into our real beliefs.
The small person-to-person bets pay off (or not) in terms of pride, including for some people the pride in betting itself. One relevant substitute is to attempt to produce pride using your own internal mental accounting of your own predictions and so we must make the broader portfolio comparison. What the $$ betters are signaling is a lack of vividness for their own internal mental worlds. In my mind, I’m already betting an optimal amount of pride through my own mental accounting. Maybe some of us are already betting too much internal pride on external events; after all, the variance of pride introduces some new exogenous risk into life and perhaps we should be trying to move in the opposite direction toward greater pride indifference to external events. That is what the Stoics thought.
Most of all, I fear that Bryan’s results are coming from an asymmetric approach where he applies positive observation to large portfolios and normative recommendations to small bets. Bryan could go for a “positive vs. positive” comparison, in which case he would point out that people trade and adjust their large portfolios all the time, but don’t make small bets on public policy nearly as much. Alternatively, he could try a “normative vs. normative” comparison, in which case would you sooner recommend that people drop their inertia for their large portfolios or for their small ones? To even raise such a question is to answer it.
Do you want to find out “what a person really thinks”? Look at whom they married, how much money they spend, and how they devote their time. That is the most important portfolio of them all.
Just don’t bet that Bryan and I are going to agree anytime soon.