30 November 2008
Gains are for retirement. Losses are immediate. In other words, we as human beings feel pain twice as much as pleasure. At this time of year I might even draw on Jimmy Stewart in “It’s a Wonderful Life.” In the movie, there is a run on the bank due to a short-term fear. But by the end of the movie, George Bailey (Jimmy Stewart) helps everyone see that deposits in a bank are reinvested in the community to help everyone grow. I know it was not supposed to be a banking movie, but it illustrates how being in the right frame of mind will help us to see the picture as it really is, and is not.
Framing is important because you and I are not rational or irrational, we are normal. We are sometimes normal smart and sometimes normal not-so-smart. As human beings we get through life by searching for patterns so that our brain can function quickly. If we are acting normal smart, we find patterns where they exist. If we are acting normal not-so-smart, we find patterns where they do not exist. And this is where today’s stock market can be so dangerous. Too many pundits – whether on television or your next door neighbor – claim to have found the pattern that will make you money or avoid losses. But what we all have to be careful of is understanding that hindsight does not mean foresight.
Hindsight bias is an affliction investors must avoid. It is easy to use stock charts or a piece of news to assume that the next movement to occur will be like the last movement in the market. Even easier than that is to assume that the nagging feeling my brother had in April was an emotion I should have acted on to avoid the market today. Hindsight bias leads us into a sense of security because in a moment of time when we cannot control the daily movement of the market, we can at least control our thoughts. But if our thoughts are based only on hindsight or by what we know (availability bias – judging probability by what is available to memory – i.e. mutual funds promote their five-star winners so investors assume they can only win by investing in those funds) today, we will surely miss the signs we need to make the best decision for us and our families.
If you want to look for patterns, be normal smart. Think long-term. In the long-term, a normal smart pattern will point to an economy that is resilient through downturns. In the long-term, a normal smart pattern will point to buying low and selling high - today the market is low. In the long-term, a normal smart pattern will point to goals that need to be achieved and lives that need to be lived – think about what has changed in your life in the last two months outside of what the news tells you. In the long-term, a normal smart pattern will point to George Bailey.
George Bailey trudges through life looking at the patterns of his life as though everything he did had no impact on anyone. And in the end he learned that life truly is wonderful, and that his patterns impacted everyone. It is time for us normal smart investors to understand that the patterns of the stock market in the long-term will get us to the goals we have for our family. We just need to ignore our neighbors.