“My broker showed me how great my investment performance has been over the last few years!”
How many times have you heard—or made—that statement?
While we all know that past performance doesn’t equate to future performance, our brains get dazzled by those 5-star rankings. Or that jaw-dropping return from last week/last month/last year. Somehow, a voice (I call it the “Voice of Greed”) inside us insists that it can only continue to rise. Unfortunately, that voice drowns out your other—more reasonable—source of wisdom that knows that markets don’t only go up.
Your “Voice of Wisdom” will tell you that:
- Star ratings are relative to what’s hot and what’s not.
- Down years are normal.
- Your stocks don’t know you own them and don’t care how much you REALLY want them to rise.
- Every bit of public information is already factored into the price of securities—regardless of what broadcast pundits (or those who sell investment newsletters) have to say.
- There is a type of risk in every security.
- Trying to time the market is waste of time for all but a very, very, very small number of individuals on the planet—and YOU are not one of them.
- If monkeys throwing darts at the stock page typically outperform the experts, your chance of consistent success is even worse (unless you’re the missing link).
Markets and performance are like catnip to cats or honey to bears—the vision of untold wealth makes us a little crazy. Our Voice of Greed shouts down the “reason region” of our brains. We dream of hitting the lotto, the super jackpot on the nickel slots, the trifecta (with all the long-shots). Our brains write the fantasy fiction stories of our successful financial lives.
It’s not a bad thing, if you can keep it in check and not let that “somebody’s gotta win” attitude take over. You can recover from small mistakes; the big ones can kill you. Your hunches, bets, beliefs are all skewed by your wiring and you can sometimes suffer from “confirmation bias”.
Confirmation bias is what happens when you start to see only what confirms what you already know or believe. Let’s say you want to research a possible investment—a stock you’re excited about. You’ve heard they’re coming out with a hot new product and when you scour the internet, you don’t notice the articles that suggest just maybe this new product is too little, too late. The competition has something even more promising. You wind up seeing only one side of the situation—you buy the stock and it tanks.
The flip side is also true—you hear some bad news rumor (and selectively read those voices of gloom and doom). Before you know it, you’re selling the stock even though it could very well be poised for a break-through.
Investopedia summarizes it nicely: “Confirmation bias is a source of investor overconfidence and helps explain why bulls tend to remain bullish and bears tend to remain bearish regardless of what is actually happening in the market. Confirmation bias helps explain why markets do not always behave rationally.”
Yep. We fall victim to our own thinking. And then when our (theoretically) well-conceived plan ends in disaster, we are left looking for an explanation that takes us off the hook. After all, we did our research and make a well thought out decision. Or maybe not.
Right now, markets are at record highs and speculation is rampant as to what will happen next. Instead of buying into the hype of the so-called experts, consider instead how much risk you can live with and what your time horizon looks like. Market corrections are normal—but if you are investing funds you’re going to need in the short-term, you are probably taking too big a risk.
Maybe it’s time to listen to your Voice of Wisdom; it might be softer than your Voice of Greed, but it might just protect you from disaster.
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