Do you want to become a better stock investor?
If you do, you’re the exception, not the rule.
I have spoken with thousands of stock investors over the past 20 years in conversations with them held on the internet. I have been surprised by how few have a genuine interest in becoming better investors.
Q1 2022 hedge fund letters, conferences and more
Emotions About Stock Investing
The primary emotion that most people have about stock investing is a defensive one. They don’t want to mess up. That makes people want to follow the crowd. One investor said it to me quite bluntly. I argued that, if Shiller is right that irrational exuberance always disappears into the wind in time, things look bad for stock investors when stock prices are as high as they are today. He didn’t argue with me that prices are not high or that the irrational exuberance will not disappear into the wind in time. But he showed no willingness to lower his high stock allocation. He said that, if stock prices crashed, he would be in the same boat as millions of others and he could live with that.
It was good that this fellow was willing to speak so frankly. But it was frustrating to hear his message. The Efficient Market Theory, which is the foundation stone for most of the investing advice heard today, posits that all investors are engaged in the rational pursuit of their self-interest. In theory, that’s why it is not possible to time the market. If everyone is always acting rationally, the price of stocks is always the proper one. So it is not possible for an individual to outsmart the market as a whole. Timing could not work in those circumstances.
But if most investors are more concerned with not looking foolish than with earning the best possible return at the lowest possible risk, all of that is out the window. In those circumstances, stock prices could rise to crazy high levels and few investors would be motivated to do anything about it. They would just sit back and watch the price crash arrive. No one would even try to get out of the market before it crashed, worrying that, if they acted too soon, they would look foolish for jumping the gun. It would be better to go down with the ship than to make choices aimed at protecting one’s assets that required one to take action before the rest of the crowd was prepared to do so.
In other fields, people strive to be the best. Actors aim to score the prime roles. Baseball players strive to hit more home runs than anyone else, not to hit an average number of home runs. In the investment field, things are messed up. People do not want to excel, they want to blend in. They want to do as well as all of their friends, not better or worse.
The Concept Of Loss
The behavioral finance people say that losses make a bigger impression on people than gains. So stock investors should be risk-averse. If that were so, it would not be possible for the CAPE value to rise to the level where it resides today. I don’t think that the behavioral finance people are wrong. It’s just that the concept of “loss” has a different meaning in the stock investing context. The loss that people want to avoid is missing out on gains that others get to experience. For many stock investors, it would be worse to miss out on a 20 percent gain and then to also miss out on a 50 percent loss than to celebrate the 20 percent gain with the crowd and then be able to commiserate with the crowd over the 50 percent loss.
Rational thought is the product of a solitary endeavor. We don’t think in crowds. We think for ourselves. We take action in crowds. But it is not thoughtful action. Stock investing is a group activity. We are always turning to others for support for the choices that we have made. We don’t want to hear insights that could generate profits for us. We want assurances that we have done the right thing. Emotional support is sought more than profits.
I believe that the driver here is that people are compelled to invest. Not everyone enjoys learning about stock investing. Many would take a pass if that were an option. But the experts tell us (correctly) that it is not possible to finance a middle-class retirement without being willing to invest in stocks. But people who don’t enjoy an activity are not motivated to learn enough about it to do it well. It makes people anxious to put their money at risk in an activity that they do not fully understand. So they are always looking for reassurance that they are not doing anything wrong. That comes to matter more than learning how to increase return or how to minimize risk.
When everyone else is selling, the investors who stuck with their high stock allocation at times of crazy high prices look to sell too. Not because it is the smart thing to do. Because it is the socially safe thing to do. We create bull markets as a community and then we bring them down the same way.
Rob’s bio is here.