Psychology Vs. Serenity

Psychology vs. Serenity 

 

Last year I wrote a series focused on psychological barriers investors face.  The conclusion was the way we are wired to think lends itself to poor investment performance.   Interestingly, it’s the same wiring that kept us alive for millennia. 

Our brains are constructed to distinguish patterns and act on logical outcomes.  Our emotions then come into play, reinforcing our rational conclusions.  Markets, however, are wholly unpredictable, irrational, and only present a pattern long after the fact. 

When considering our money our greatest challenge is to overcome innate psychological conclusions which tempt us to do the wrong thing at the wrong time.  Below are summaries of common battles we face.

OVERCONFIDENCE

Studies show that people are exceedingly overconfident when it comes to assessing our ability compared to others.   Nobody wants to be average…or worse…so most of us tend to believe we are above average even when we are not.

In a world where economic information surrounds us, many feel able to interpret this information in a useful way.  In truth, anything we see in the media has already been priced into the market, so even if we are correct in predicting what is likely to happen, it is too late to profit from it.

RECENCY BIAS

Recency Bias is over-weighting the relevance of recent experiences in regard to what will happen in the future.  Four years ago the DOW dropped to 6500.  At the time, everyone in the media was predicting how long it would take to drop to 3000. 

The tone and tenor was set by recent declines, and the interpretation was eventually we would get to 0.    The DOW set an all-time high of 15,637 this week.

Our strongest feelings are around what is happening in the present.  The valence can be so strong it seems that, for better or worse, those feelings (and the reasons for having them) will never end. 

CONFIRMATION BIAS

Being a sentient species has its advantages; including a superior intellect capable of creation, empathy, and pattern recognition.  But this also comes with pitfalls.
 
Humans tend to form conclusions long before all the relevant data is in.  In fact, we draw conclusions within a few seconds of being presented with most situations.  Because of our superior intellect, we know it is highly unlikely our first thought is wrong. 

Confirmation bias is our natural inclination to seek and accept evidence that confirms our beliefs – the same beliefs we formed automatically.  Because of this bias, we also reject evidence suggesting our conclusion may be inaccurate.

REGRET

People feel sorrow and even grief after having made an error in judgment.  When things aren’t going as we want, we regret our decisions and actions that precipitated where we are in the moment. 

Investors seeing their values decline will often regret not holding onto cash, even knowing the purchasing power of cash declines everyday due to inflation.  Some will react and sell low, leading to further regret they weren’t invested when things rebounded.

THE PSYCHOLOGICAL ROLLERCOASTER:

The chart below is from investment author Frank Armstrong illustrating the cycle of emotions we feel as investors throughout unpredictable markets. 





It is a wonderful visual to study and lock away in our cognitive (unemotional) mind. Armstrong writes:

“…under-performance quickly generates remorse and regret. These emotions in turn trigger an almost irresistible impulse to buy and sell at exactly the wrong moment.”
 
A simple way to avoid this outcome is to remember: The best time to invest, and stay invested, is always now.  Acting on our biases and emotions generally doesn't result in an optimal outcome – in our out of investing.
 
Here is a checklist I use when feeling the need to take action:
 
1)    Just because I want to know what’s going to happen, doesn't mean I do know what’s going to happen.
2)    What I’m experiencing and feeling now will change.
3)    I’m allowed to believe whatever I want, but that doesn't make it true.
4)    Some of the greatest things in my life have come from things I previously regretted.
5)    Serenity comes from the wisdom of knowing when to do nothing.
 
Congratulations to those who stayed invested and kept investing into a globally allocated portfolio.  By staying on the coaster you have squashed bank interest rates.  You have crushed gold.  And most importantly you have outpaced inflation.  You should be feeling pretty smart about now.

I welcome your questions and comments.

Marc Becker
Accredited Investment Fiduciary
Managing Partner, Wiser Financial Coaching, LLC
Wiser Financial Coaching, LLC, is a Registered Investment Advisor Firm

DOW - The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends. This is not a solicitation or recommendation to purchase or sell any investment product or service, and should not be relied upon as such. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The views and strategies described may not be suitable for all investors.