Human pessimism hurts performance of investments
March 10, 2016
One of the most interesting aspects of investing is human nature.
Understanding investments is difficult. Understanding human behaviour often seems impossible.
Many times the weak link in the investment process is not the investments, it is human investors. There has been endless investment research that links poor investor decision-making as the main cause for financial failure.
Regardless of mounds of evidence on the best way to invest, we humans continue to get it wrong much of the time.
That might be because we tend to be more focused on dangers than opportunities.
Daniel Kahneman won the Nobel Prize several years ago for his research showing that people have stronger negative feelings than positive. Investors are many times more unhappy with an investment decline than they are happy with the same amount of positive gain.
Historian Deidre McCloskey told The New York Times recently “For reasons I never understood, people like to hear that the world is going to hell.”
General investment conversation often gravitates to the many possible risks ahead that might cause investors to lose money. Yes there is investment risk but it is unhealthy to focus on just the downside.
Wharton professor Jeremy Siegel has made a career in studying stock market performance since the beginning of markets. His conclusion is that stocks are the safest asset class investment over the long term.
Some people in United States wonder if Professor Siegel is too optimistic for being so enthusiastic about historic stock market returns. He has been preaching this since the 1980s and stock markets have continued to provide excellent long-term returns.
You can bet against optimism but evidence is not on your side. Since economic activity and stock market values started being recorded over 200 years ago the results have been solid growth.
Yes there are times when the market corrects itself. However, for two centuries results have been positive.
Harvard Professor Teresa Amabile’s research shows critics writing negative book reviews are seen as smarter than those writing positive reviews of the same book.
Professor Amabile said: “Only pessimism sounds profound. Optimism sounds superficial.”
Our suggestion is to be aware of natural human tendencies and to try to avoid the pitfalls of viewing investment opportunities as mostly negative.
As stated above, yes there is risk to investing. However, for most people, there is even a greater risk of not investing in stocks for the long term.
In order to reduce your long-term risk of not achieving your financial objectives like assisting your children with the post- secondary education or planning for retirement, you are encouraged to take some short-term risk.
There will be times where short-term performance is disappointing. But do the math: You need to have an acceptable rate of return on your investments to achieve your financial objectives.
That positive return is only possible by accepting a certain amount of risk.
The world is not ending. Stock markets are not likely to crash as often as people predict.
Try to harness your natural human emotion and develop an investment portfolio that has the best chance of allowing you to achieve your financial objectives.