“Most people buy the highest quality television sets, only to watch the lowest quality television shows.
― Jarod Kintz
When I was a kid, I used to watch ESPN quite a bit. I played several sports and was pretty active, so watching sports on television was a pretty natural extension of my interests. One of the shows which I’d occasionally watch was Friday Night Fights, the boxing show. I remember the days of Howard Cosell calling the Muhammad Ali fights; my grandparents used to think that my Howard Cosell imitations were quite precocious. That was back in the days when fights went 15 rounds, and the boxers were just as aggressive in the fifteenth round as they were in the first round.
When I went to West Point, not only did I take the mandatory plebe boxing class, I boxed for intramurals one year. Let’s be clear up front. Unlike Ali, I stung like a butterfly and floated like a bee. The matches were three rounds of 90 seconds – half the time of a professional boxing round. I was in pretty decent cardiovascular shape, but boxing was an entirely different spectrum of lung busting. Usually, by the end of the second round, I was ready to cut a second passageway from my stomach into my lungs just to get more air in there.
It looked so much easier on television.
Boxing isn’t the only activity which looks much easier on television than it is in real life. A study commissioned by the Boston Federal Reserve examined the sources of financial panics and market declines. Unsurprisingly, panic was the primary descriptive term used in association with precipitous market declines. The panic occurs when an event which we thought was nearly impossible happens, and once it does, we’re completely unprepared to deal with the outcomes, and we hit the panic button, ejecting from the market and selling everything – usually at the bottom of the market.
Panic works both ways in the market. It doesn’t just affect people on the way down. When a market is rising, people also fear that they won’t be able to participate and that they’ll be left behind as the Dow skyrockets to 1,784,484,485 by next week. So, they buy in a rush, cursing themselves for not buying sooner than they did, but then confident that at least they’ll catch the rest of the bull market. It’s loss aversion in reverse – they have a mental picture of the market being even further up and having not participated, creating a loss in Monkey Brain’s memory banks. We know that Monkey Brain doesn’t like to lose, so he convinces us to plow all of our money into the market, right when it’s at the top, usually.
Why are we so apt to participate in the bipolar behavior of the markets?
- The democratization of information has caused us to become comfortable with the stock market. Because information about the stock market is so readily available, either through watching CNBC or scouring the Internet for discussion boards and blogs about every investing topic under the sun, we feel like we know a lot of information. We do. It’s not just a feeling. We all know a good deal about markets, stocks, and the economy because the information is fed to us day after day. Because of this rising tide of investor knowledge, skill takes a back seat to luck in explaining portfolio performance. Even though rising information has caused an increase in the role of luck in our investments, we still think that just because we saw something on CNBC or on the Motley Fool, nobody else will have that information, and we’ll have an inside investing edge. Familiarity has bred overconfidence, and when that confidence takes a beating because something doesn’t work out the way we thought it would, we panic.
- We think we’re “experts” because of familiarity. Television has a way of making things look easy. You watch Lionel Messi weave through eight defenders and put the ball beyond the goalkeeper’s outstretched fingertips into the upper corner of the goal and you think “ah, can’t be that hard, can it?” If you watch Jim Cramer make recommendations on stocks during Mad Money, the ease with which he rattles off information makes you think that it can’t be terribly hard to get to that point. If Messi or Cramer can do it, so can Monkey Brain. After all, we’re better looking than average, better drivers, and smarter than the average Joe, so we must certainly be better investors too, right? As the saying in Texas Hold ‘Em goes, it takes a few minutes to learn, and a lifetime to master.
- Our familiarity and overconfidence reduces fear and dread. You can certainly remember times when you’ve had more butterflies than acid in your stomach, and, alternatively, when you’ve thought “I’ve got this” because you knew that you could do something. When you’re confident about and familiar with something, you don’t have fear and dread about performing the task. When you think you know what you’re doing, then you’re more comfortable taking on more risk because of your confidence. When this translates into an investing strategy, it means that you take many more swings for the fences, trading higher risk investments like options strategies or single stock investing because you think you know what you’re doing and it can’t go wrong. The high risk strategies are the ones that, if they don’t work out, can represent the greatest losses. As the maxim goes, with high reward comes high risk, and many more times than not, you’re going to lose in those high risk swings. Unless you have a significant amount of capital to be able to weather large swings in your portfolio, once you see a couple of your investments go wrong, you’ll extrapolate the bad outcome to all of them and panic, meaning that you’ll probably sell low, compounding your misery.
- We think emotionally rather than statistically. Monkey Brain likes to tell stories. Sometimes, the stories aren’t always accurate because memory is a funny thing and recounting exactly what happened takes a lot of effort and energy – two things that Monkey Brain doesn’t like to expend. So, we wind up creating our own revisionist history that makes us look like we’ve done better than we probably actually did. It’s literary license on our own diaries. However, no matter how much fudging Monkey Brain does with our personal histories, we get very emotionally attached to them. We get so emotionally attached to them that it’s easier to lean back on those experiences – fabricated or not – as validation for our actions, even if we’re faced with statistical evidence which goes in the face of what we believe. Thus, information from experience – the Monkey Brain history book – will dominate statistical information, even if the statistical information is better. Monkey Brain don’t need no stinkin’ math, lies, damn lies, or statistics.
Thus, fed by our own ego, we believe that we know more about the markets than we really do, and that we can, using information which everyone else has access to and none of the analytical processes which truly separate out the few high performers from the lucky, give the markets a good old-fashioned shellacking, invest for a few years using whatever system we come up with, strike it rich, and retire.
Except, almost always, something happens along the way to retirement which puts a major dent in our plans. That false sense of familiarity and comfort with investing in the markets that we got from watching CNBC or reading a bunch of bloggers comes crashing down when the market doesn’t react the way we think it’s supposed to. We hit the panic button.
How can we keep our blood pressure down and hide the panic button when investing in the markets?
- Value cost average. If you have a plan and stick to it, investing at regular intervals and value cost averaging along the way, you’re more likely to be able to buy low and sell high and not deviate from the plan. Value cost averaging incorporates market ups and downs.
- Use reframing. If you watch television and read the Internet, you think that a 10% drop in the market is terrible and that Chicken Little was right. Instead, think of it as a buying opportunity and that the market is on sale. If you’re value cost averaging, you’ll be buying more shares when the market is down and getting rid of them when it goes up.
- Think long term. For most people, the day of financial reckoning is still a long way away. Your retirement savings is not going to be made by one smart trade today, although it’s possible to put a significant damper on your progress by making a series of panicked decisions. Instead, focus on making a series of intelligent, reasoned moves and stop trying to think that you have some sort of insider information or a new insight that nobody else has that’s going to make you do that much better than everyone else.
If you can think in terms of matching market performance rather than beating market performance, your overall investment experience will be much better. You won’t be prone to taking outsized risks due, in part, to overconfidence gleaned from seeing the “experts” on television making it look easy. Instead, using a smart plan, periodic monitoring (NOT EVERY DAY), and having other things to do with your life rather than goad yourself into overtrading because you watch too much television will make your life much simpler and more rewarding.
The simple life is not something which television can make look easy.
What do you think? Does seeing something on television or the Internet lure into a false sense of overconfidence? Tell us your experiences in the comments below!
Around a year ago, I wrote about how raising your spending to match your income will lead to doom. If you haven’t read it, go check it out!
- John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.
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