Comprehensive financial planning is a complex endeavor, and professionals such as lawyers and doctors are particularly susceptible to making mistakes in this domain. The demanding nature of their careers, coupled with unique factors related to their professions, can contribute to behavioral mistakes and biases that hinder their investment success. While many people believe they can handle their finances independently, without proper guidance or experience, they could be putting themselves at more risk than they realize.
Warren Buffett, regarded by many as the greatest investor of our time, once said, “It won’t be the economy that will do in investors; it will be investors themselves.” This statement may be particularly true for lawyers and doctors. In his book Behavioral Investment Counseling, Nick Murray identifies the “eight great behavioral mistakes” investors often make. In this article, I explore why lawyers and doctors are especially prone to these pitfalls.
The Demands of the Legal and Medical Professions
I’ve practiced law for nearly 30 years, formerly as a partner in a large law firm, and have represented many doctors. I know first-hand that both professions can be extremely time consuming, often requiring 12-, 14-, or 18-hour days. On top of the thousands of hours lawyers work annually to meet the needs of their clients, most law firms expect lawyers to spend hundreds of additional hours on client development, professional growth, and continuing legal education. Similarly, in addition to the long hours doctors dedicate to patient care around the clock, they spend many more hours on research and keeping up with advancements in their respective fields. These demanding schedules can result in limited time for comprehensive financial planning and lead to suboptimal decision-making, increasing the likelihood of the behavioral mistakes discussed below.
Overconfidence and Expertise
The expertise that lawyers and doctors possess in their professional fields does not necessarily translate to expertise in financial matters. Research in behavioral finance suggests that individuals with high levels of expertise in one domain may exhibit overconfidence in unrelated areas, including financial decision-making. This overconfidence can lead to neglecting proper analysis, underestimating risk, and making impulsive investment choices based on recent successes rather than careful analysis.
Unique Financial Planning Challenges
Lawyers and doctors often have unique financial planning challenges. For example, both professions typically involve high student loans and a delayed start to full-time employment due to extensive education and training. As a result, these professionals feel pressure to quickly accumulate wealth, which can lead to hasty investment decisions and a lack of long-term perspective. As American economist Paul Samuelson put it, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
Additionally, the high-income potential in these professions can create a false sense of security, leading to lifestyle inflation and poor savings habits. The pressure to maintain a certain lifestyle or repay significant student loan debt may divert attention from prudent financial planning strategies.
The Eight Great Behavioral Mistakes
In Behavioral Investment Counseling, widely regarded as a seminal work in the field of investment counseling, Murray emphasizes how long-term, real-life returns are only marginally affected by the relative performance of specific investments. Rather, they are absolutely driven by the behavior of investors. To drive the point, he discusses a study known as the Quantitative Analysis of Investor Behavior that has been updated annually since 1994. The study examines the behavior and investment returns of individual investors and demonstrates that they tend to buy and sell at the wrong times, often driven by emotional reactions to market volatility. As a result, they tend to underperform the markets and professional investors over the long term on average by approximately 6% per year!
In Chapter 7 of his book, Preventing Disaster Before It Happens: The Eight Great Behavioral Mistakes, Murray discusses the most common mistakes that investors make that can lead to disastrous investment outcomes. Let’s delve into these mistakes and consider why lawyers and doctors are particularly likely to make some of them.
- Overdiversification: Spreading investments across too many different securities or asset classes can dilute returns and make it harder to track performance. Lawyers and doctors, with their demanding schedules, are more likely to find it challenging to dedicate sufficient time and attention to their investment portfolios. This time constraint can lead to overdiversification as they accumulate investments without effectively managing them. As legendary investor Peter Lynch warned, “Owning stocks is like having children—don’t get involved with more than you can handle.”
- Underdiversification: Concentrating investments in too few securities, industries, or asset classes can increase risk and volatility, leading to large losses if those investments perform poorly. The intense focus and specialization often required in the legal and medical professions, together with overconfidence, can translate into a tendency to concentrate investments in sectors or asset classes, particularly when a lawyer or doctor “knows” that this product will be a success.
- Euphoria: Often mislabeled as “greed,” investors may become overconfident and buy investments in which they have already seen significant gains. In a state of euphoria, investors often buy at high prices and set themselves up for potential losses. The demanding nature of legal and medical work, coupled with the high salaries they offer, can contribute to a sense of euphoria.
- Panic: When markets decline sharply, investors may become fearful and sell their investments at low prices, locking in losses and missing potential opportunities for recovery. Lawyers and doctors often experience intense stress in their demanding careers. When faced with market downturns or economic uncertainties, this stress can escalate into panic, causing hasty and ill-advised investment decisions.
- Leverage: Borrowing money to invest can magnify returns but can also magnify losses and lead to a total loss of invested capital. High salaries earned by lawyers and doctors can create a false sense of security and the temptation to engage in risky investment strategies involving leverage.
- Mistaking speculating for investing: Investors who take speculative positions may think they are investing, but they are actually making bets on short-term market movements, which can lead to significant losses. The demanding hours and fast-paced nature of legal and medical work leave lawyers and doctors with limited time to conduct thorough research and due diligence on potential investments. Buying on a hunch is speculating.
- Investing for current yield instead of for total return: Focusing solely on current income from investments can lead investors to overlook the importance of long-term total returns. Lawyers and doctors nearing retirement or dealing with significant financial pressures may prioritize current income over long-term total returns.
- Letting the cost basis affect investment decisions: Loss aversion is a cognitive bias that describes why investors tend to hold investments longer than they should: the pain of losing money is psychologically twice as powerful as the pleasure of gaining money. The cost one paid should not be a factor in determining the investment’s current value and whether the investment is a desirable component of a well-diversified portfolio. The demanding nature of lawyers and doctors, often accompanied by long hours, can limit the time necessary for them to carefully review their investment portfolios and ignore the cost.
As Murray points out in his book, individual investors are prone to making common behavioral mistakes that have significant long-term consequences on their portfolios that far exceed the management fees financial advisors may charge (typically less than 1% of assets under management). Legal and medical careers with long hours, high salaries, and unique characteristics increase the likelihood that lawyers and doctors will suffer from these behavioral mistakes. At EsqWealth, we work closely with our clients to help them avoid them and make informed decisions about their investments, ultimately helping them achieve their long-term financial goals.