The Triumph of the Optimists

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We here at Liberty Through Wealth are unabashed optimists.

You’ve probably read Alexander Green’s columns on the work of Harvard’s Steven Pinker and Sweden’s Hans Rosling on why the world is better than you think it is.

I’m always surprised by the blowback Alex gets from some readers.

They take a sort of perverse pleasure in pointing out how bad things really are.

It’s almost as if most humans are wired to be pessimistic.

In fact, you may be wired the same way.

If so, it’s worth reminding yourself of this valuable lesson…

Overcoming your pessimism may be the single most important secret to becoming a successful investor.

Investor Pessimism as a Cognitive Bias

Regular readers know that I’m a big fan of psychology and behavioral finance. (My wife has a couple of doctorates in psychology, so it runs in the family!)

Both fields focus on “cognitive biases.”

A cognitive bias is an unconscious mental trick you play on yourself to shoehorn your reality to fit your beliefs.

For example…

“Confirmation bias” makes you give more credibility to arguments with which you already agree.

“Recency bias” means that the last thing you read has more impact on you than the first.

“Hindsight bias” happens when you tell yourself, “I knew it all along.”

So it’s no surprise that the pioneers of cognitive biases were not economists or business school professors…

But a pair of psychologists: Princeton’s Daniel Kahneman and Stanford’s late Amos Tversky.

Ironically, Kahneman went on to win a Nobel Prize in economics. (He had never taken an economics course in his life.)

Yet I believe there is one crucial cognitive bias Kahneman and Tversky missed…

And that is the cognitive bias of “investor pessimism”…

Because when it comes to being a successful investor, understanding your cognitive biases is far more important than, say, building a whiz-bang spreadsheet to value a company.

Why So Many Pessimists?

Scan any financial media outlet, and the din of the pessimists always seems the loudest.

There are many explanations for this.

Here are two…

First, the media has a negative bias. It’s no secret that sensational headlines sell newspapers and generate click-throughs.

As the adage goes, “If it bleeds, it leads” – even if what is “bleeding” is the value of your portfolio.

Second, optimism can be career-threatening.

Think of a fund manager worried about his job.

If he’s pessimistic but wrong – his clients will breathe a sigh of relief.

If he’s optimistic but wrong – well, he may soon be sending out resumes.

In short, if you’re sitting at Fidelity or BlackRock managing money, there’s no upside to being an optimist.

Why the Optimists Will Triumph

In 1994, Jeremy Siegel – a finance professor at the Wharton School – published the investment classic Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies.

His basic argument? Invest in U.S. stocks, and you can expect long-term returns between 6.5% and 7% after inflation.

Looking forward, I am even more optimistic than Siegel.

Thanks to widespread adoption of technology – improved communications, artificial intelligence and an explosion in human creativity – economic productivity is set to spike and boost investment returns even further.

As I’ve pointed out, even a 1% or 2% increase in productivity could make a massive difference in your returns.

Don’t Be Like Bill

A few years ago, I was managing retirement accounts for a client named Bill.

It was the spring of 2015. And Bill was convinced the U.S. stock market was due for a crash. So – against my advice – Bill liquidated his portfolio and went to 100% cash.

As it turns out, Bill was wrong.

Since March 2015, the S&P 500 has risen close to 33%. And for every million dollars in his portfolio, Bill lost out on gains of $330,000.

The lesson?

Too often, investors succumb to the cognitive bias of pessimism and try to call a market top.

Almost invariably, they are poorer for it.

The greatest danger in investing is not the prospect of losing your shirt in the next stock market crash.

The greatest danger is being a pessimist and staying out of the market altogether.

In the end, the optimists will always triumph.

Good investing,

Nicholas

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