Cycles of Dumb: Part Four

By Gary Silverman, CFP®

We’re in our fourth week of looking at what makes smart people do dumb things with their investing. So far we’ve seen how Recency Bias makes us think that what just happened will continue to happen. We saw how Overconfidence led us to believe that we not only know what we are doing, but that we know better than most anyone around us. And Herd Mentality brought in the masses.

In the late 1990s an extended bull market combined with a true game-changer—the Internet—to create a stock bubble like none we had seen since the roaring ‘20s. But then at the turn of the millennium some people began to realize that this new industry, while promising, wasn’t really making any money. Almost imperceptibly things turned.

 Only a few left the market at first. They were either extremely jittery investors or those with little skin in the game. Most did not get scared out of the market…initially. After all, even those periodicals targeting investment professionals had begun to say that true bear markets were a thing of the past. Sure, there would be rotating bear markets—in theory only affecting one sector at a time—but nothing that would bring the entire stock market to its knees at once. Those who disagreed were said to just not understand the new globally linked economy. I think psychologists would call this denial.

But as losses began to mount, and as losses spread from the tech industry into the market as a whole, it was harder to look at this as just a buying opportunity. As doubt entered the consciousness of the investors who had never seen a bear market, traces of fear emerged. You may remember hearing (or saying):  “When xyz stock gets back to what I paid for it, I’ll get out.”

Here we begin to see Risk Aversion start to kick in. Research has shown that people feel a lot more pain in losing $50 than the equivalent joy they might feel in gaining $100. As investors began to see losses, their natural Risk Aversion kicked in. They finally realized that losses were real, but were bargaining with fate. Sure, on paper they had now lost money, but all they had to do was wait and all would be okay. This sentiment has some basis in truth, but not in the way they were applying it. With few exceptions bargaining with fate did not work, and the slide continued, broadened, and accelerated. Panic set in. Herd Mentality works in the downward direction, too.

Now the refrain shifted from getting out once their losses were eliminated to getting out before all was lost. Herd Mentality caused a stampede, as investors by the millions capitulated and sold all of their holdings. They “knew” that if they didn’t, there wouldn’t be any holdings left to sell.

The greatest bull market in history was over. We’ll remember how things got turned around next week.

This article was published in the Wichita Falls  Times Record News on September 18, 2016.