DIY Investor Magazine
|
Oct 2017
39
EXPERTS
Emboldened by the 2008-2009 financial crisis, various
‘perma-bears’ have spent most of the last eight years
warning that overvalued equity markets are headed
for another crash of epic proportions. ‘perma-bears’
have spent most of the last eight years warning that
overvalued equity markets are headed for another crash’
There is a large appetite for apocalyptic commentary,
as evidenced by the continued success of doom-laden
financial websites such as Zero Hedge and the media
attention given to commentators such as Marc ‘Dr
Doom’ Faber, who has been warning since 2010 that
markets are headed for a 1987-style market crash.
This is an age-old problem. Way back in 1828, John
Stuart Mill wrote: ‘I have observed that not the man who
hopes when others despair, but the man who despairs
when others hope, is admired by a large class of
persons as a sage.’
The same point is noted by influential Harvard
psychologist Steven Pinker, author of The Better
Angels of our Nature, which cites a mountain of
data showing that, contrary to popular belief, human
violence has decreased enormously over the centuries.
People tend to be wrongly convinced that the world
is going downhill, says Pinker, whose reflections on
the psychology of pessimism can also be applied to
investors.
SMART PESSIMISTS?
The main problem is that pessimism is ‘intellectually
seductive in a way optimism only wishes it could
be’, as Morgan Housel from the New York-based
Collaborative Fund noted recently. Studies bear out
Housel’s contention that pessimism seems smarter
than optimism. One study concluded that people
who wrote negative book reviews ‘were perceived as
more intelligent, competent, and expert than positive
reviewers, even when the content of the positive
review was independently judged as being of higher
quality and greater forcefulness’. Other studies show
when people are asked to impress others with their
intelligence, they trot out negative and critical opinions.
Not only are pessimists and critics seen as smarter,
they are also seen as more ‘morally engaged’, says
Pinker. Consequently, investors may perceive bullish
commentators as superficial salesmen while their
bearish brethren are mistaken for forthright truth-tellers.
Thirdly, there is the ‘bad is stronger than good’ effect,
as documented by psychologist Roy Baumeister.
The pain of a euro lost dwarfs the joy of a euro gained;
criticism hurts more than praise encourages; bad
information is processed more closely and attentively
than good information.
As Baumeister puts it, ‘bad is stronger than good, as
a general principle’, which means investors will almost
invariably be excessively tuned into the possibility
(however remote) of losing money. These emotional
biases towards pessimism are compounded by a
cognitive bias, says Pinker, notably the so-called
availability bias documented by behavioural finance
expert and Nobel laureate Daniel Kahneman.
The availability bias refers to our tendency to make
judgments about the likelihood of an event based on
how easily an example comes to mind. Time in the
market and compound interest drive investment returns.
However, that’s not news so it doesn’t readily come to
mind. On the other hand, it is news when stocks fall 20%
in a single day, as they did on Black Monday in October
1987. That freak event continues to spook investors,
many of whom are unaware that stocks nevertheless
finished the year slightly higher!
WHAT TO DO?
The TCF Investment perspective is simple:
1.
If you can’t afford any loss – keep your money
in cash – but beware of the inflation risk!
2.
Have a plan and understand your attitude to
risk and capacity for loss – this is best created
with the assistance of a professional
financial adviser.
3.
Align your portfolio to this risk profile and
your time horizon.
4.
Makes sure it is diversified – a
sset classes, managers and securities
5.
Rebalance occasionally to keep the portfolio
at the risk risk level
6.
Keep it low cost – ongoing and dealing fees
7.
Make it tax efficient where possible
8.
If you are really nervous – drip feed money into
your portfolio – this will reduce the risk
(and of course the return too).
O’Mahony concludes ‘Investors should take note.
Pessimism can sound smart, but the history of equity
markets suggests optimism pays better’.
From an original article by Proinsias O’Mahony,
The Irish Times
