It’s easy to have a false sense of confidence and ability on the internet. I have a personal finance blog. But that does not make me an expert in personal finance. But I am learning. And I enjoy discussing what I am learning.
I’ve been investing on my own for a few years now, and have definitely improved my process. With that being said, I realize that I still have a lot to learn and experience. I am 22 years old and have never been through a true bear market as an investor. There were a few mild downward swings in August 2015 and January 2016, but these instances do not come anywhere close to the carnage of 2008, the dot com bubble of the early 2000s or the flash crash in the late 1980s.
I’ve only been involved with bull markets. So far, I’m a bear market virgin.
Humans are emotional beings. Humans are subject to cognitive biases. And I am human. I am emotional. I am subject to these biases.
It is one thing learning about our biases. It is another thing to be conscious and able to overcome them when taking action. Here are a couple money related biases that I succumb to and find difficult to overcome:
The Herd Mentality
In the picture below, which line in Exhibit 2 is the same length as the line of Exhibit 1?
Social psychologist Solomon Asch added a twist to this simple test. He had seven people in a room. Asch recruited six of the seven participants to deliberately give the wrong answer. The seventh participant, who was the only non-actor, was the last person to give their answer. The results were shocking. Most people chose the incorrect line, despite being so obviously wrong, just because the other six participants did so.
The wise Warren Buffett once said: “Be fearful when others are greedy, but greedy when others are fearful.” When everybody is selling is precisely the time you should be buying more. But this is easier said than done. It is extremely difficult to do the opposite of what everyone else is doing. As Asch’s study shows, heading the wrong direction with other people is easier than going the right way by yourself. There is comfort in numbers.
I hate losing money. I say that from experience, and I really haven’t experienced that much. August of 2015 and January of 2016 were tough months, and I know there will be worse times in my investing career. This risk is something that I have to deal with, and luckily I do have time on my side. But this does not make losing money, even in the short term, any less painful.
This idea is known as loss aversion. People feel loses more deeply that gains of the same value. In other words, the pain of losing $1000 is far greater than the pleasure of winning $1000. We like winning, but we hate losing. This raises an interesting point – pretty much everything we hear and read about is on the topic of winning. Nassim Taleb said, “Bookstores are full of books on how someone became successful; there are almost no books with the title what I learned going bust or ten mistakes to avoid in life.” So despite losing being more painful, most things we consume are focused on the winners. Seems a bit backwards, doesn’t it? Maybe we should put more of a focus on learning about the failures, as opposed to trying to imitate the winners.
Learning about the above biases is helpful, but only time will tell how I will react to them when a bear market does happen. Hopefully the bad times will bring good lessons.
I’ve used this quote from Fred Schwed Jr. before, but I feel like it is a great way to wrap up this post:
“There are certain things in life that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximately explain what it feels like to lose a real chunk of money that you used to own.”
Are you a bear market virgin?