Investors’ human nature leans towards pessimism
September 29, 2016
Why do investors often think their investments perform worse than they actually do?
This is not a rhetorical question. It does happen. I have had many conversations with investors who are discouraged about their investment performance. Then, when they review the return on investment details, they are relieved and impressed.
I am not aware of any evidence that explains this, however, I will offer some suggestions on why this form of negativity might happen.
We do know from academic research that those who convey negative thoughts and opinions have more credibility than those who have optimistic opinions.
For example: if someone wrote an article saying the US would go into a deep recession if certain circumstances were to occur, I believe the author of that article would seem like a very credible source. The negative views would be given instant credibility such that another article saying the exact opposite may be discounted.
The common sense explanation is that humans generally prefer bad news. I believe humans are programmed to receive bad news so are more likely to accept negative investment or economic forecasts.
Sometimes the preference for negative news is exploited on the basis that it sells. Could that explain why investors first look for negativity of investment returns? Is that just how our brain is programmed? Is our automatic default to look for negativity?
We also know from other academic research that humans have an inversion to loss. When anticipating an investment loss or gain, the potential of a loss is twice as significant as the potential of a gain of the same amount.
The human brain is twice as focused on losses as it is on gains. The natural tendency to emphasize loss could be the reasons why investors think pessimistically about their personal investing. Again, it is how the human brain is programmed that dictates how we think.
A cautionary word to investors: monitor your investment strategy and performance with facts, not illusions. Let the numbers speak for themselves. If your estimated long-term investment objective is to earn an annual 6% return on investment, then I recommend you evaluate your long-term performance based on how well your investments performed.
Your long-term objectives will not be reached by overreacting or misinterpreting the reality.
A question for the readers of this column: Do these human tendencies interfere with your logical thinking that is required to produce good long-term investment returns?
One symptom of negativity bias I have seen over the years is when individuals have a significant amount of their assets not invested. A large amount of money sitting in the bank making virtually no interest.
That often is a symptom of an investor who is focused on negativity and will accept no return on a significant part of their portfolio in order to avoid any investment risk.
My suggestion is to continually monitor your financial and investing progress with facts and try to control the illusions that are just a natural part of being human.