Smart folks, dumb decisions

By Gary Silverman, CFP®

This is week 5 in a series of my observations of what causes intelligent people to do dumb things with their portfolios. Last week we ended with the tech bubble crash where the Overconfidence of the investing masses met its match in the reality of finance. Tech stocks plummeted in the year 2000 as millions left the market knowing that otherwise they would “lose it all.”

Those of you who think I’m going to tell you this was the market bottom are wrong. The bottom did come, but not until the second half of 2002. Even then it took another six months and some perilous-looking times before any rally could get stocks out of their slump.

Out of the slump they came. Not with the veracity of the late ‘90s, but it was certainly a strong bull market. This wasn’t going to sucker in the depressed investing masses. No, they learned their lessons. Stocks were a fool’s game where reality turned the board over just as you started winning. They weren’t going to play again.

This is where another dumb trigger comes to play: Hindsight Bias. This happens when folks think it’s obvious that what had happened was going to happen. That obviousness comes not from true predictability but from hindsight. When you add a previously discussed dumb trigger, Overconfidence, investors begin to think that they can predict the next fill-in-the-blank. That they weren’t able to do it before doesn’t matter. They’re smart now. So they waited.

And stocks continued to go up.

What happened to Recency Bias that we mentioned a couple weeks ago, the tendency for us to extrapolate the recent past into the far future? With stocks continuing to rise, wouldn’t that get people back into the market? It did to an extent. But there is also Risk Aversion. For many that was the overriding behavior modifier.

While the stock market will turn your losses into gains if you just wait long enough, that is not true with individual stocks. Some never return to their glory while others never recover at all. Since there was a tech bubble that burst and since a lot of people had most if not all of their investments in internet- related stocks, they lost a disproportionate amount of their portfolio value and a great number of companies they were investing in went bye-bye permanently. Risk Aversion was strong.

Yet the market kept going up. The painful memories began to wane. The behavioral effects of Risk Aversion weakened, leaving room to be replaced by Recency Bias, Overconfidence, and Herd Mentality (though nowhere near the levels seen in the late ‘90s).

We’ll get to the land mine that the markets were marching toward next week.

This article was published in the Wichita Falls Times Record News on September 25, 2016.