Among the many quirks our brains have is something called the “fading affect bias.” Basically, we aren’t very good at remembering negative emotions. Our brains shrink the memories of bad times, painful experiences and anything generally unpleasant.
That is generally a good thing.
But could it be that we carry this bias into our portfolios as well.
That is generally a dangerous thing.
Two main ways this bias can lead us astray
ONE: The fading affect bias (and its cousin, optimism bias) promotes speculation.
Imagine you speculate on a high-flying small-cap green-tech stock and it gets obliterated. If you held on to the pain of that past loss, you might be discouraged from such foolishness again in the future. But when your biases kick in, you could be tempted to minimize the pain of that experience and allow yourself to be distracted by pleasant memories of your occasional winning trades. And so you’re at the watering hole aka stock market again, looking for the next big payout.
TWO: The real danger for most long-term investors is minimizing past bear markets.
Bear markets can be terrifying. Even the “little” hiccups terrify us. The big selloff on Wall Street to start 2016 with the worst four-day start to the year ever, Chinese shares plummeting, that thing called Brexit, that thing called Zika Virus, that hiccup causing your daughter to vomit in the car (I totally made up the last one).
And then, a month later, we laugh at ourselves. It was nothing, we say. It seems so obvious in hindsight (hindsight bias) that it would turn into just a brief dip in our portfolios (I am sure your daughter’s episode made no dent in your portfolio whatsoever though).
But that’s not how we treat the next one.
The next one seems real.
Those little events of the past, sure, they were no big deal.
But tomorrow’s news?
Tomorrow’s news is different.
Tomorrow’s news is scary.
Tomorrow’s news could be the big one.
Could it be that news shows are just filling the needs of people who try to justify their unhappiness with all of the doom and gloom in the world?
Are you prepared? – Let’s exercise
A good exercise for today could be to spend some time forcing yourself to remember being scared about the markets. Force yourself to relive the anxiety and worry of being down 5% and wondering if 20% is coming next. Remember what it was like to worry that disease was spreading or economic collapse was around the corner.
Not because this alone is a good practice, but because it is going to happen again, and sooner than you think. You can’t pick a time in history that something scary wasn’t around the corner. The odds of an investor experiencing a big market crash during their life are about 100%!
You need to hold on to those past moments and then recognize that even though it was truly scary life moved on and markets recovered and the world didn’t come to an end. So that when next time the fear comes, you think “this is scary and unpleasant and a little awful, and it was last time too, but this time I will scoop up some bargains!”
To end this post on a more positive note: Always reach for the thought that feels best. When you feel good you’ll attract more of the good things in life. There is always a better thought than what you are thinking right now.
Such as “Profits in shares are like damages for pain and suffering. First the pain, then followed by some suffering resulting in some money later.”
Ahem, was that really a better thought?
My apologies, in case you do not see it that way.
Let me have a second attempt then “We’re all better than Einstein. Because he’s dead.”
“The funniest thing about markets is that all past crashes are viewed as an opportunity, but all current and future crashes are viewed as a risk.” – Morgan Housel
“You have power over your mind – not outside events. Realize this, and you will find strength.” – Marcus Aurelius