That’s right, the single largest risk to investors is themselves.
By that, I, of course, mean the influence of human emotion and psychology in decision making.
It seems quite clear to me that humans are uniquely wired incorrectly for long-term investment success.
When asset prices double, we want those assets twice as bad, but when asset prices drop in half, we want nothing to do with them.
This intuitive behaviour, inherited from our ancestors, is a disadvantage in the modern world.
We call far too many cognitive biases our own. In this case, however, more doesn’t equal better. They’re merely a basic part of how humans in general think, not the sort of defect we could blame on a terrible upbringing or a rotten personality. Everything about us is built on the echoes of our ancestors’ struggles and victories.
Having evolved in East Africa, not only are we now confronted on a daily basis with situations far removed from those we encountered as hunter-gathers, we also have a huge amount of evolutionary baggage that makes us ill-equipped to deal with many aspects of modernity.
This doesn’t mean that all of our choices are irrational or ridiculous, or that we should simply curl into a fetal position and give up dealing with our incredible modern world. We simply need to be on our toes and recognize that today’s world rewards single-minded contemplation, good reasoning, and independent action.
Lazy decision making driven by emotion, as opposed to logic, is the single greatest impediment to long term investment success.
There’s an old saying in the markets: “Human decision making never changes, only the wallets do.”
Therefore, we need to anticipate potential emotional triggers so that we can better confront and soften our own human responses to market outcomes.
For investors, there’s probably no greater human emotional trigger than actual price volatility itself. If we can anticipate and understand why price volatility might occur, we can dampen our emotions and objectively steer through the unpredictability of market cycles. That’s why we study historic chart patterns and statistics on market performances.
The good news is that just being aware of how our brain works greatly improves our chances of keeping both feet planted in reality. When we realize that our brain is playing its own game by its own rules, we know better than to trust it unconditionally, and we are better prepared to take on the world of investing.
Better—but by far not completely prepared.
Humans aren’t perfect reasoners or perfect decision-makers, any more than we’re perfect calculators. The human brain evolved by process of addition over 400,000 years, like a coal shed converted into a mansion by piecemeal extensions.
Whilst we have unique human capabilities for rational thought, the mammalian and reptilian parts of our brain dominate when we’re stressed, tired, hung-over, or fearful.
Even at our best, we don’t compute the exact right answer to “What should I think?” and “What should I do?” We lack the time and computing power—and evolution lacked the engineering expertise and foresight—to iron out all our bugs.
Human beings make mistakes, and not all of them are disguised successes. And human beings will continue to make mistakes; it’s inevitable. We should just say “Oops!”, get on with our life, and be prepared to change quickly.
And sometimes in life, it’s even like this: “I was wrong, but I made the right mistake. I learn from it and will not give up.”
“Forgive yourself for your faults and your mistakes and move on.” — Les Brown
“To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.” — George Soros
“When the facts change, I change my mind. What do you do, sir?” — John Maynard Keynes when he was asked about why he switched his position on monetary policy