Ludwig Wittgenstein, the Austrian-British philosopher/logician, once said that “nothing is as difficult for people as not deceiving themselves”. We would add that “while many self-delusions are relatively costless, those relating to investment can come with a hefty price tag.”
As humans we delude ourselves for a number of reasons, but one of the principal causes is a need to protect our own egos. We look for external evidence that supports the myths we hold about ourselves and we dismiss evidence that is contradictory.
Psychologists call this “confirmation bias”—a tendency to select facts that suit our own internal beliefs. A related ingrained tendency, known as “hindsight bias”, involves seeing everything as obvious and predictable after the fact.
These biases, or ways of protecting our egos from reality, are manifested in investor behavior every day and are, unfortunately, encouraged by the deafening noise of the financial press.
Here are seven common manifestations of how investors fool themselves:
- Everyone Saw That Market Crash Coming – Have you noticed how people become experts after the fact? If ‘everyone’ could see a correction coming, why didn’t ‘everyone’ profit from it?Our Advice = Don’t Pay Attention To Forecasts!
- I’m Waiting For More Certainty – Uncertainty goes with investing. The emotions triggered by short-term uncertainty are understandable, but acting on those emotions can be counterproductive. Over the long-haul, discipline has, historically, rewarded investors.
Our Advice = Have A Plan, Maintain Discipline And Expect Volatility!
- I Only Invest In ‘Blue-Chip’ Companies – People often gravitate to the familiar and to companies they see as solid. But a company’s profile and whether or not it is a good investment are not necessarily correlated.
Our Advice = Diversify!
- I Know This Industry, So I’m Going To Buy The Stock – People assume that success in investment requires special knowledge of a sector…but…that information is usually already in the price.
Our Advice = Trust The Collective Wisdom Of The Market!
- It Was Still A Good Call, But No One Saw This Coming – Isn’t that the point? You can rationalize a stock or bond over-weight bet as much as you like, but, events or external influences take you by surprise.
Our Advice = Always Balance Your Risks!
- I’m Going To Restrict My Portfolio To The Strongest Economies – If an economy performs strongly, that will no doubt be reflected in stock prices. What moves prices is news. And news relates to the unexpected.
Our Advice = Think Long-Term!
- OK, It Was A Bad Idea, But I Don’t Want To Sell At A Loss – Holding onto a losing bet (or even a winning bet) may translate into missing better opportunities elsewhere.
Our Advice = Always Do The Best You Can With The Resources You Have Today!
This is by no means an exhaustive list of destructive self-deceptive behavior. Examples of humans deluding themselves in the world of investment are beyond the scope of this missive.
However – Overcoming Self-Deception Is Not Impossible! It starts with recognizing that, as humans, we are not wired for disciplined investing. We too often find one way or another to rationalize an emotional reaction to market events. We are compelled to fool ourselves.
To quote folk wisdom, “the essence of self-discipline is to do the important thing rather than the urgent thing”. We view ‘the first important thing’ as objectively assessing your goals, values, needs, resources and obligations. With these assessments in clear focus – develop a realistic plan and then do ‘the next important thing’ – Stick To It!
We’ve enclosed two charts that quantify Short-Term Volatility and Long-Term Returns:
- Bull And Bear Markets – This chart looks at US Large Cap Stocks (the S&P 500) from 1926 through June of 2013 with a twist…rather than looking at Long-Term Appreciation this chart reveals the Ying-Yang of Bull Markets and Bear Markets. Curiously, Bull Markets have historically lasted longer than Bear Markets and Bull Markets have generated returns that significantly outrun the drawdowns of Bear Markets.
- The Capital Markets Have Rewarded Long-Term Investors – This chart reveals the unmolested eighty-seven year growth of wealth in five different asset classes ranging from relatively safe to relatively risky. Buy and Hold practiced with discipline.
Trusting this will find you completely human – indulging in ‘Confirmation Bias’ and basking in ‘Hindsight Bias’ – yet, blessed with the intellect to Plan Unemotionally, we remain.