When markets hit a rough patch—as they did in early April—investors often lose confidence. Emotions run high after paper losses, and that’s when many fall into the “ready, fire, aim” trap. Decisions become reactive, not disciplined. It’s common to see investors flee to cash or pivot to more conservative positions in an effort to feel safer. But more often than not, resisting that urge is the better path. In this episode of Simple, But Not Easy, we sit down with Morningstar’s Global Chief Research & Investment Officer, Dan Kemp, to explore how advisors can guide clients through uncertainty—not with bold predictions, but by remaining anchored to a clear investment philosophy.
Episode Show Notes
Our guest this month was Dan Kemp, Morningstar's Chief Research & Investment Officer. If you’d like to see more from Dan, be sure to check out his Weekly Market Roundup—which provides bite-sized updates on important financial matters for the week ahead.
Transcript
Nicholas VanDerSchie: Global equity markets have been volatile this year. And that maybe a trend investors need to get more comfortable with. Volatility can rattle even the most seasoned investors. Making it easy to second guess the plan overreact to headlines or let emotion take the wheel. But long term investing goes beyond stock picking and having the perfect asset allocation. Its about sticking to sound principles especially when its hardest to do so.
In this episode, we're diving in to unpack some of the most important reminders for navigating turbulent markets. From foundational do's and don'ts, to building more resilient portfolios and avoiding common behavioral traps, this conversation is all about helping advisors guide clients with clarity, and perspective exactly what's needed when uncertainty is high.
Hello and welcome to Simple, but Not Easy, a podcast from Morningstar's Wealth Group where we turn complicated financial developments into actionable ideas. I'm Nick VanDerSchie, Head of Strategy and Execution for Morningstar Wealth and I'm delighted to be joined by Dan Kemp, Morningstar's Chief Research and Investment Officer.
Before we get into the conversation, if you'd like to know more about how we support advisors, we welcome you to email us at simple@morningstar.com or me directly at nicholas.vanderschie@morningstar.com. Now, let's get started. Dan, welcome to Simple, but Not Easy.
Dan Kemp: Nick, it is great to be here. Thank you so much for inviting me on.
VanDerSchie: We're glad to have you. So as Morningstar's chief research and investment officer, I know this is not your first time on the podcast, but it's actually your first time back since I took over hosting duties a couple of years ago. Really glad to have you and appreciate you taking the time today. Before we jump into the conversation, our listeners would love to hear what you and your team have been up to at Morningstar since your last appearance on the show.
Kemp: Oh, there's been a bit going on, hasn't it Nick? Let's first of all deal with some of the incredible market movements that we've seen both first of all that incredible run up in technology stocks and the enthusiasm that people had for those stocks beyond all others. That's certainly a challenge that we've had to deal with. And then more recently, of course, all of the tariffs. And I know we'll be talking about that a little bit later. And so much of what we try to do all the time is stay calm, follow the precedes of this podcast, which is that it is simple, but it is not easy. And understand that our first response should always be research over reaction.
So whatever the market's been throwing at us over the last couple of years, really our focus has been on research, understanding what's going on, looking deeply at the changes that we're seeing and what that really means for investors. And then, of course, trying to communicate what we're finding, whether it's through the changes that we're making to portfolios, through the investment management team, or the research that we're publishing on Morningstar.com and other platforms. What we're really focused on is helping investors make good decisions in what we can all agree is a very confusing environment.
VanDerSchie: Well, great. Thanks for that, Dan. And I'm really looking forward to getting into the conversation. And where I'd like to start is to talk about some of the dos and don'ts, right? Some guiding principles. And as you know, one of our main areas of focus with advisors right now is helping them put today's market volatility in perspective for their clients. And volatility isn't new, but it does have a way of catching investors off guard. And so simple do and don't reminders, especially when grounded in historical context, tend to go a long way. And although some of the principles I'd like to talk about today may seem obvious, in moments of stress, they are absolutely worth reinforcing.
So to start, Dan, as we see when markets start to get turbulent, investors sometimes have this tendency to question everything. After all, the human instinct is to often react and do something. So one of our core investment principles here at Morningstar is that we take a fundamental approach. And I'd like to ask you, how does taking a fundamental approach apply during times of volatility?
Kemp: That is a great question, Nick, because that is the most difficult time naturally to take a fundamental approach. I think I'd start by taking a step back and saying that investing should always be focused on the long term. Sometimes people talk about long term investing, some people talk about short term investing, but in reality, short term investing isn't investing. It is just gambling. We don't know what's going to drive prices in the short term. There's nothing wrong with it. It's just unlikely to help you get to your financial goals. So investing is always about the long term because over the long term, we have a reasonable idea of what is going to drive returns. And the thing that is going to be most important when delivering returns for investors is going to be the quality of the businesses, the quality of the assets that you're buying. And so in order to assess that quality, in order to understand whether you're buying a high quality asset or a low quality asset, then you have to do deep fundamental research.
And as I mentioned earlier, that's what we spend so much of our time doing here at Morningstar, whether it's in the manager research team, the equity research team, the investment management team. It's all about doing that deep fundamental research. And for people that are less familiar with fundamental research, it's a bit like the experience of buying a used car. We all know that when buying a used car, the seller has an advantage on us because they know all of the flaws in the car. They know whether it needs a service, in needs new gearbox, whatever it is. And the only way that we can understand whether it's a high quality car, whether it's worth the money we want to spend on it, is if we do deep research into that car. And many of us will be used to doing that sort of research on many, many purchases, not just cars, but homes and even fridges in some cases. But in reality, of course, investment is so much more important because it's a much bigger financial commitment of ours.
So our team spends their time doing that deep fundamental research. And because we focus our research and investment activities on those fundamental principles, we tend to stay pretty set in our ideas and our views, even when people are panicking around us. So one of the things that we try to do when going through the sort of periods we've seen over the last month or so is to keep calm, keep doing that research and not overreacting.
VanDerSchie: So Dan, if our listeners want to buy a new car or a refrigerator, I'll send them your way. Okay.
Kemp: Ah, please do.
VanDerSchie: All right. So building on that, waiting for the proverbial dust to settle during market volatility can feel like a safe bet at times, letting the headlines improve and sentiment turn before investing may sound more comfortable. But as you know, Dan, one of our core investment principles is that price matters. And so why is focusing on price an effective investing framework during these times?
Kemp: That's exactly right, Nick, that price is so important. And I think sometimes we forget that there are always two prices for any asset, for any company. There is a price that reflects the fair value, the real value of the asset and the price at which you can either buy or sell it today. Now, normally, as viewers will know, there could be a slight difference in the price you are buying or selling. But let's say that that's one price. They're normally quite similar these days. So there's one price at which you can transact today and there is a fair value, which is the real price of the asset that reflects a reasonable estimate of the future return that an investor will see. And so the market price is essentially a barometer of the prevailing market sentiment.
Now, most of the time the market price is pretty similar to the fair price of the asset. Those two prices are pretty close together. But sometimes optimistic investors will push that market price, the price at which you can transact today far too high. And as you push that price higher, it reduces future returns because over the long term we'd expect the price of any asset to move back to its fair value. So when optimists in the market or there is a great groundswell of optimism as we saw last year, that can push prices well above that fair market price or realistic estimate of that fair market price. Equally, there are times when people are feeling very pessimistic. We've seen this over the last month or so where prices fall rapidly and then those prices can go below that realistic estimate of the fair price. And when that happens, then there's a real opportunity for investors to buy an asset at below its real value to get a discount on that asset, on that business. And that will likely boost future returns.
And so when people think about waiting for the dust to settle, often they're missing the fact that when people are panicking, when prices are falling, that's when you get the best returns. We can think of it a little bit like farming. The planting, when you're sowing the seeds of the future, is typically done in the bad weather of the winter and early spring. And nobody wants to be out there in the fields planting when it's raining and potentially even snowing sometimes, that's not great for planting. But no one wants to be out there in the bad weather. But if you wait until the good weather comes along to plant your crop, then it's very unlikely that you'll get a good harvest. And so in order to get that good harvest, you've got to be out there in the bad weather planting those seeds, investing your excess capital, because that's when you're going to be sowing the seeds that are going to deliver that harvest when prices recover.
VanDerSchie: Dan, that's good perspective. And we're going to get to some of those opportunities a little later in the discussion. And I don't want to disclose your age here, but I think it's fair to say that you've been a professional investor for decades and lived through many challenging markets. And as I'm sure you've experienced, the data can often show that fear can be an opportunity. Can you give me your perspective on that?
Kemp: Yes, absolutely, Nick. Yes, you're right. I am of an early vintage. Yes, and I learned a long time ago that the best investments are made when I'm most afraid, because that normally means that prices are unusually low and everyone can only see the downside. People remember those times that could be 2008, 2009 after the financial crisis. It could be earlier 2001 during that depression that followed the dotcom boom. It could be after the Russian debt defaulted in '98 or even earlier doing the savings loan crisis when everyone can only see the downside. That's when the best investments are made. So investing when afraid and ideally investing when absolutely terrified are likely to be when you make the best investments. But of course, like any investing journey, the danger is that you change your mind if you invest too much and then you can't stand the subsequent ups and downs of markets, which I know we'll talk about a little bit later on.
So invest when terrified, but make sure that you're not investing so much that you can't stay with those investments as that recovery comes through, because the recoveries tend not to be in a straight line. They tend to be pretty bumpy, and so you have to be able to see that investment through until it matures. So invest when terrified, but don't overinvest because that can have downsides as well.
VanDerSchie: No, that's fair. You know, another concept I think about is recency bias, which often takes hold during volatile markets and maybe we'll touch on that a little more later. But one key message advisors should likely think about or potentially reinforce is not to pretend to know what's coming in the short term. Dan, why is that kind of humility so important?
Kemp: Yeah, I think it's essential, Nick. It's essential because we really don't know what the future will hold. Quite often we get taken in by people who can convince us that they can predict the future, but frankly no one can. If anything is to be learned from the last month or so, it is that the future is unpredictable and can change very rapidly. And we've seen many examples of this through the past. And so because the future is genuinely uncertain, people who invest with one very strong perspective typically get undone because they can't deal with the twists and turns that the future has to hold. So some of the people who are most confident about what the future holds and most confident about making investments can deliver terrible returns because they're not thinking correctly about the range of possible outcomes that the future can hold.
And I was talking to a colleague recently and I was saying to them that what I'm most proud about with our team is not that they are very smart and very hardworking. They're both of those things, but there's lots and lots of people around the world engaged in investing who are smart and hardworking. What I'm proud about our team is their humility, that they're constantly focused on what they don't know and how they try to express that unknown future to investors and advisors. So whether that's through the portfolios they run or through the research they publish, it's all about explaining that the future holds a range of possible outcomes. And we have to be able to think about that, that there's various outcomes, there's various range of possibilities rather than fixating on one possible outcome.
And you mentioned recency bias, that's really important because so often our view of the future is shaped by what has just happened and that's a terrible way to invest. So always we have to be focused on that uncertainty, thinking about what we don't know, what we're mistaken about and trying to think in terms of probabilities or odds would be another way of thinking about that, trying to think in terms of probabilities or odds rather than have one fixed view of the future.
VanDerSchie: That makes great sense Dan, thanks for sharing that perspective. One area where we observe investors potentially getting tripped up is in how they define risk, right? And volatility and risk are terms that are sometimes used interchangeably, but I think you would agree that they're not the same and that confusion can sometimes lead to mistakes. Can you expand on that a little? How should investors be thinking about the differences between risk and volatility?
Kemp: Yes, absolutely. So volatility is in its simplest form the normal up and down of prices. And as I mentioned earlier, that up and down is really driven by the emotions of investors. Stock prices move around far more than they should given the underlying changes in businesses. They move around because sometimes people wake up and they're feeling optimistic and sometimes they wake up and they're feeling pessimistic. And so volatility is simply a statistical measure of how wide those ups and downs are. It's a bit like travelling on a rollercoaster. If you're on a rollercoaster, there's lots of ups and downs. It can be quite exciting, but there's not a great deal of risk on a normal rollercoaster.
Whereas risk, real risk, is the danger that investors don't reach their goals because their capital is destroyed. And there's a couple of ways that people's capital can be destroyed. Sometimes you can buy something that has no real value, that tragically happens. Occasionally it often happens in fraud and things like that, but sometimes people can buy things that has no real value. The other time it happens is when people are forced to sell or they choose to sell when prices are very low and they never get that capital back, either because they don't re-engage in markets, they don't reinvest, or they wait until the coast is clear, everything's very optimistic again, and then they invest and go through that rollercoaster again. So think of genuine risk as like getting on a rollercoaster that's not complete. The danger is not in the up and down that happens on the track. The danger is when you hit a gap in the track and fall off. That's where the real risk is. So as far as people can ignore that up and down, market volatility, that's a really important character of successful investors, but you really want to avoid the genuine risks that can destroy your capital.
VanDerSchie: All right, so you heard it here first. Do not get on a rollercoaster unless it's completed. Understood, Dan, got it.
Kemp: Exactly, right. Simple, but not easy.
VanDerSchie: So we've covered some great principles in the discussion so far, but as we like to do on this podcast, let's start talking about how advisors can make these principles tangible and kind of put some of these concepts into action. As we often say here at Morningstar, Dan, execution is everything. So I'd love to take a deeper dive on how we get these ideas put into action. So Dan, we're I'd like to start, we often hear about this important concept of a margin of safety and investing, but what does that mean in the context of portfolio construction? How can advisors incorporate this concept to build more resilient portfolios, especially before markets turn volatile?
Kemp: Yeah, absolutely, Nick. So the margin of safety is another way of describing that gap between the two prices I mentioned earlier. So you have the intrinsic value, the real value, the real price of a business, and then you have the market price, the price at which you can transact today. And if the price at which you can transact today, the market price is lower than the real value, then that provides a margin of safety. And so two things that advisors can do. The first is try to buy assets naturally below their intrinsic valuation. So you can use Morningstar's research to help you do this. We publish our estimate for the real value of businesses and also their price, and therefore the implied margin of safety on Morningstar.com and on other platforms. And so you can go there and you can look for assets, look for stocks that offer that margin of safety. And the second thing to think about is that your required margin of safety should be guided by the quality of the asset.
So the higher the quality of the asset or the quality of the business, the higher the price you can pay, the less margin of safety you need because things are less likely to go wrong. So at Morningstar, we describe that as a company's moat rating. So we think about stocks the way that Warren Buffett thinks about stocks, that a great company is one that's able to build a moat around their business to protect it from competitors. And so if you have a nice wide moat, then your business is going to be safer. That's a measure of quality. So if you can buy a business with a nice big moat and below its intrinsic value, then that's really the jackpot. That's exactly what you're looking for, but quite often you can't do that. And so allow the quality of the asset to guide how big the margin of safety you need.
So if you're buying a low quality asset and the world is full of low quality assets, you can buy them, you can get great investment returns out of low quality assets, but you want to make sure that you've got a wide margin of safety. So in most portfolios, you'll want a mix of higher priced businesses that are of high quality and then probably some lower quality businesses, businesses trading at very deep discounts to their fair value. And that will both help dampen some of that volatility, but also give you an opportunity to deliver higher returns for your investors over time.
VanDerSchie: Yeah, very practical guidance there for advisors who are managing money. Thanks for that. Dan, it can sometimes feel like when the markets get volatile, the advice is simply to white-knuckle the portfolio and you'll be fine, because that's what history says. But I don't think that's the message that we want to send. In fact, volatility, as you alluded to earlier, can also bring opportunities. So let's maybe dive in a little bit there. How do you think about spotting and taking advantage of those opportunities when they arise? And are there any examples that come to mind?
Kemp: Yeah, sure. And I think when we think about that white knuckling, the portfolio it's that idea of the rollercoaster of course, that you need to stay on the track. The people who are challenged, the people who suffer real risk is when the car that they're in is no longer attached to the track, whether they have fall off or the track's broken. So just as long as you're staying on the track, and it may be a white knuckle ride, but that will get you to your goals if you have a well-constructed portfolio. But as you say, there are lots of examples where, instead of just trying to stay on the track, you wanted to take additional risk at times when it was very unpopular, times when it was very challenging. And this is something that we spend a lot of time with the portfolio management team doing, trying to encourage portfolio managers to find stocks and assets that are really unloved and offer great returns to investors, provided we can be patient, provided we've properly assessed that margin of safety.
Now, one of the greatest signs of this is when somebody tells you that an asset or a business is uninvestable. That is like having a big neon sign above the asset saying, investigate this. There's probably some great returns there. Because when everyone thinks something is uninvestable, that normally means that it's sort of a very large margin of safety relative to its fair value. So some good examples would be, let's say, energy companies in 2020. When everyone was saying, well, the pandemic's here and energy futures, you remember, went briefly negative for one afternoon. Energy prices were incredibly low. People weren't getting on planes, they weren't driving their cars, and people thought that energy demand would collapse.
Well, we didn't think that. We did a lot of research into energy companies. And actually, we realized there were some great investments here providing these energy companies stop doing so much investment, which they duly did. And of course, that then led to not only a recovery in energy prices, but also great returns in those energy company stocks and that carried on until quite recently. So that's the example from the pandemic. More recently in 2022, people were getting very upset with some of the technology companies because of all the money they were spending. Meta was really the poster child of this and the metaverse investing it was doing. And that drove the price well below what our equity analysts sort of said was the fair value. And so we saw real opportunities, not just in Meta, but communication technology stocks, in 2022, we were able to buy those for clients, portfolios, really attractive valuations.
If you go back through time. Every time there was a really big period of negative sentiment, there's always opportunities. The key is for people to sift through the rubble of whatever damage has been done and find those opportunities. Most recently, during the tariff turmoil that we've seen over the last few weeks, although some stocks dropped very sharply and portfolio managers were rebalancing and adding to some of their holdings, we didn't feel that any of the stocks got so incredibly cheap that people were wondering around saying, well, these stocks are now uninvestable. So we didn't quite get there in the last few weeks, but that doesn't mean we won't get there in the future. So whatever the next crisis is, look through the rubble, look for things that people tell you are uninvestable, and that's where the best future returns are likely to be.
VanDerSchie: Yeah, Dan. And those are great examples of historical stock market opportunities. During volatile times, the emotional reaction of the stock market tends to be what investors focus on. But the same thing can be true in bond markets as well, right? Can you maybe walk us through some of the observations we've seen recently in the high yield bond space?
Kemp: Yeah, of course, Nick. So this is where I get so concerned about investors, because for most of us, the reason we have bonds in our portfolios is to offset some of that volatility, , to make it a little bit easier for us to stay on the rollercoaster. But that is dependent on the idea that bonds will protect you. But most of the time, they do provide that counterbalance to stock. But there is a class of bonds where there are additional risks. And these used to be called junk bonds. More recently, they'd be renamed high yield bonds. But they're typically loans made to companies that aren't as good quality credit. And so there's always a bit of a risk that these companies won't be able to pay back those loans. And if they can't pay back those loans, then of course they default and people can lose their capital in the worst outcome. And so when we're looking at high yield bonds, then we think of them very differently to treasuries. And when we're investing in high yield bonds, we want to see a much higher yield, hence the name, from those higher risk bonds than we'd get from treasuries. And for the technically minded out there, this is known as the credit spread. And sometimes the spread is wide, meaning that you get a lot extra return. And that can make it a very attractive asset. Again, not an asset that's likely to protect you, but an attractive asset.
And sometimes you get a very narrow spread, which means that the returns are going to be just a little bit above treasuries. You're carrying that additional risk. And if things go wrong, you could lose some of your money. Now, what some people do is they try and get high yield bonds into portfolios to juice up the return a little bit. And it's often very tempting for investors to do that because they see the high yield, but they don't think about the risk. But there's a great lesson for us all in what's happened over the last few weeks. If anyone out there reads my weekly market review, you'll know that I've been flagging that spreads have been very narrow recently. They got to historic lows over the last few months. But as soon as the tariff turmoil happened, then those spreads spiked higher.
So the spread on high yield bonds went from about 2.6% to about 4.6%, which meant that the price of high yield bonds fell by about 3.1%. Well, obviously that's not what people want from a bond portfolio. If they're expecting that to smooth out their returns, it added to that volatility. So high yield bonds can be a great investment at the right price. But it's really important to understand that they're unlikely to provide that counterbalance to your stock risk. And so use them as you would a risky asset rather than one designed to protect the portfolio. There was a lot about bond (maths) there, Nick. I hope that made some sense.
VanDerSchie: Yeah, it makes good sense. And for our listeners, we'll go ahead and post your weekly market review in the show notes so they can double click on that if they're interested in learning more. So we've focused lot of the conversation today so far on solid investment principles and current opportunities. But I want to flip it and talk a little bit about some of the traps to avoid. And Dan, you know better than anyone, Morningstar places a huge emphasis on behavioral finance. And we have a team here that does a lot of great work in that field. One of the key ideas is that some of the biggest investing threats or impediments to achieving our long term goals aren't always market related. Rather, they're on us.
They're inside of us. And so, you know, before we get into some specific behavioral biases, I want to zoom out for a moment and share that old saying, the higher the VIX, the higher the clicks. Basically, when markets get choppy, people tend to consume a lot more financial media. And we see that to be true even on our own sites at Morningstar. But not all of it is helpful. And some of it can actually feed into fear or poor decision making. So Dan, what advice would you give on how to consume financial media without getting swept up in all the noise or hyperbole?
Kemp: Nick, that is so important. You're absolutely right again that there is so much danger in getting sucked into this echo chamber of moment by moment analysis and short term thinking. As I mentioned, right at the top of the show, short term investing is gambling. And so, of course, one way that you could think about some financial media out there is that it is enabling, encouraging, highlighting financial gambling rather than long term investing. And that's not to denigrate the great journalists, the wonderful shows that they're putting on. They are typically catering to traders, folks who do need to know what's happening moment by moment. But for advisors, for our investors, then it's really important to try and block out some of that noise and take that longer term view because we're not traders. We are investing for our future. We're investing for the long term. And so, the first thing I would say is, is remember that most media organizations don't have a duty to help you to be successful as an investor.
And so, people shouldn't rely on what they are hearing from the media. I would say that at Morningstar, one of our most important values and our first investment principles is that we champion the investor. That everything we do is geared towards trying to help investors reach their goals and support them on that journey. And so, that's why we talk about the long term and we talk about fundamental research and the importance of price rather than these moment by moment movements. So, just when you're consuming financial news, it's exactly the point that you made that sometimes that can worsen the behavioral bias, it can bring out the worst instincts in us rather than encourage us to think long term, remain calm and stick to these principles that are ultimately going to help us be successful.
VanDerSchie: That's such a helpful perspective. I think it's worth reinforcing that our emotions can really work against us, especially when the headlines are loud and dramatic. And you've said before that it's important to make sure we're getting advice from the right place. And as you point out candidly, that is often not the financial media. I've often heard it said that the media has a fiduciary duty and it's not to you. Maybe you can unpack that a little bit for us. Why is it so important for advisors and their clients to be selective about where they're getting their information during these times?
Kemp: Yeah, of course. I think that the key is, Nick, to remember that we are the product of hundreds of thousands of years, if not millions of years of evolution. And when we've evolved through most of that period, it's been very advantageous for us to act when we are frightened. For most of our history as human beings, being the person that gets out of the way when you're frightened has been a very good thing to do. But we're not in that world anymore. And the world of investing, so often when you're frightened, as I mentioned earlier, that's the time where you want to either stay still and be able to ride out the volatility or run towards the risk in order to increase returns. And so we are not really well wired to do that. And if you're a financial advisor, you know that your clients aren't well wired to do that. And so if we expose ourselves to financial media, which is encouraging that fear, encouraging that short-term perspective, then that can harm financial returns.
Of course, in the worst case scenario, it can cause people to disinvest, to disengage. And so remember that when we're focused on what's coming out of the media or investment reports or the numbers we see on websites, so often that's about the one thing that we can't change, which is past performance. We always need to be forward looking. That's very, very difficult to do. So I would always encourage people to limit their consumption of financial media, particularly when the markets are volatile, because that's when we're most likely to be encouraged to do the wrong thing, not because anyone's deliberately doing that, but simply because that's naturally who we are as human beings.
VanDerSchie: All right, Dan, I'd like to move into some discussion around behavioral biases. And maybe we'll do these just rapid fire. The first one I want to start with is loss aversion. How does it affect client decisions and what can advisors do to counter it?
Kemp: So quick fire response there. Yes, loss aversion causes us to do strange things, because it causes us to be more risk averse when we suffer small losses and more risk seeking when losses are large. Now you can see this when people go into a casino. In real life, people often spend their chips very slowly to begin with, and then when they're down to their last few chips, they make bigger and bigger bets. And that happens in investment as well. And so that means that people tend not to take enough risk when losses are small and take too much risk when losses are large. And so one of the ways that people can address that, of course, is make sure that the portfolio is sufficiently well diversified and the risk people are taking is sufficiently well matched to their own personalities, their capacity of taking risk, that they never get into that risk seeking behavior, and they don't feel constrained by small losses. So it is all about that journey of losses and how to avoid people getting into that risk seeking behavior when they've experienced losses.
VanDerSchie: Okay, next one up, recency bias, which is so common, especially after considerable bull market runs, the U.S. stock market over the last decade being an obvious example. How can advisors help provide proper perspective here?
Kemp: Yes, so the best way that people can address recency bias is to focus on the future, on expected returns rather than past returns. So it is the same thing to say that somebody is on track to reach their goals as to say that they've just suffered a small loss and their portfolio is down. The two things can be exactly the same, but we respond differently if we feel like our portfolio is down versus being on track to reach our goals. So the more that advisors can help people focus on the future and away from the past, the more successful investors are likely to be. If you can't do that, then try and look at the longest possible time periods. At Morningstar, we often go back 150 years to look at investment returns because we know over those longer term periods, then it's clearer that success comes from staying invested rather than from trying to trade in that market.
VanDerSchie: And Dan, the last behavioral bias we'll cover is anchoring, right? The tendency to rely too heavily on a single piece of information when making decisions. And so for me, one example that stands out is 2020. After that 30% drop in March, markets rebounded pretty quickly, but many pundits kept saying that we have to retest the lows. That I guess felt intuitive, but markets don't always follow the script. So what do you make of that example? And are there other anchoring moments you've seen in your career that tripped up investors?
Kemp: Yes, exactly. That's a classic example, Nick, where people were overconfident about one particular outcome and weren't thinking about that range of possible outcomes. And that's a problem with anchoring that, as you've mentioned, everyone has an anchor. We all anchor on something. And the psychologists have told us it's very difficult to remove an anchor from somebody. Once you've made a decision, once you're anchoring, then it's difficult to remove that anchor. However, you can replace the anchor as long as you create another alternative anchor, then you can move some from one anchor to another. So at Morningstar our anchor is that intrinsic value that I was talking about. The team continue to go back to time and time again is what is the fair value of an asset? That is our anchor, whether it's in equity research work that we do or in portfolio management, that's the key focus. And so once you replace that anchor of recent returns with fair value, then that changes your perspective. And you can see when stocks are becoming very cheap or becoming very expensive, and that is likely to be a more successful anchor. So don't try and take an anchor away from your clients, just swap that anchor for a better one.
VanDerSchie: Dan, we've covered a lot here in the last 45 minutes. And I think the best place to conclude is to bring us back to a simple investing truth. Investment behavior influences our outcomes more than most people probably realize. One great example of this is in Morningstar's annual Mind the Gap report, which shows that across major asset classes, investors often earn less than the funds that they invest in. Can you walk us through this? Why is that? And what drives this consistent gap between market returns and investor outcomes?
Kemp: Absolutely, Nick. Mind the Gap is my favorite piece of research that Morningstar does. It's an annual survey where we compare the fund return for mutual funds across the globe with the average return an investor in that fund receives. Now, most people would say, well, that's surely the same, but it's not the same. And it's not the same because people tend to buy and sell at the wrong time. And what we found is that people, as you said, consistently achieve returns for themselves that are lower than those achieved at the fund level because they buy and sell at the wrong time. When we're investing, the most important thing to do is to stay invested, stay focused on the long term and try to trade as infrequently as possible. Now, we've talked about taking advantage of opportunities and that's great, but the most dangerous things when people get scared and they sell out only to buy back in later or to sell out as something that's underperforming today, to buy into something that's been outperforming recently. And so Mind the Gap is a great tool in helping us to remember that the most important thing is to stay invested, stay focused on the long term. That will help you overcome these behavioral biases and likely to lead to a better outcome in the long run.
VanDerSchie: That's great. Dan, as we wrap up, I want to ask you about some recent content that the Morningstar team has created for advisors where we've taken a close look at a few of the greatest investing quotes of all time from legends like Buffett, Munger, Howard Marks and others. When you step back and look across all of them, what is the common thread that ties them together?
Kemp: Well, I think Nick, the common thread can really be summarized in our investment principles which have run through this conversation. So as you mentioned earlier, Morningstar has a set of investment principles. We have three principles and these have been built on the success and the teachings and the wisdom and the writings of people like Buffett, and Munger and Marks. And they are very simply that we champion investors. So that means that we're focused on helping investors reach their goals. If you think of the way that Buffett has invested over his career, it's never been about trying to beat an index or a peer group over the short term. It's been about growing the wealth of the investors in Berkshire Hathaway. That's been his focus. The focus is on the long-term buying great businesses and that way, he's been championing the investors.
The second is taking a fundamental approach. And so again, when we think about people like Howard Marks, his focus is always on really understanding what's going on in a bond or a stock and using that understanding to set that intrinsic value to understand what the margin of safety is and to try and find assets that are trading below that intrinsic value and provide those additional investing returns. And then finally, as we've talked about a few times, this idea of price matters. And there are various different ways that we can interpret that, but partly when we look at the work that our manager research team does in favoring funds that have low fees that champion the investor or in applying these valuation principles to stocks or to asset classes or to the portfolios that we manage, price, and particularly there's two different prices we talked about are incredibly important. And so what runs the thread through all of these great investors are, sorry, what runs like a thread through all these great investors is condensed into these three principles. So if you remember nothing else from this conversation, then take away those three principles and I hope that will help you and your investors get to your goals.
VanDerSchie: And there you have it, another episode of Simple, but Not Easy. I'd like to thank Dan for his time and engagement. And once again, if you'd like to know more about how Morningstar can support you, please drop us a note at simple@morningstar.com or me directly at nicholas.vanderschie@morningstar.com. That wraps up this month's episode. Before we depart, if you enjoy hearing the insights on our podcast, please consider leaving a five-star review on Apple Podcast or Spotify. Until next time, thanks for listening.
(Disclaimer: This podcast is produced and issued by Morningstar Investment Management LLC, a registered investment advisor and subsidiary of Morningstar, Inc. The content is intended for U.S. audiences only. Individuals featured in this podcast are employed by Morningstar, Inc. and its subsidiaries. This includes but is not limited to Morningstar Investment Management LLC and Morningstar Research Services LLC. Morningstar Investment Management and Morningstar Research Services are registered with and governed by the U.S. Securities and Exchange Commission. This podcast is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of publication. Such opinions are subject to change. No Morningstar entity, including Morningstar Investment Management and Morningstar Research Services shall be responsible for any trading decisions, damages or other losses resulting from or related to the content presented. Morningstar makes no representation as of the completeness or accuracy of the information presented. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision. This podcast is for informational purposes only. Does not constitute investment advice and references to specific securities or other investment options mentioned are not an offer to buy or sell that specific investment.)