In the world of Wall Street, it doesn’t matter who you are, how smart you are, or what kind of edge you think you have if you don’t know the most basic truth – your own brain is absolutely committed to screwing you over.
The markets are hilariously good at humiliating people who don’t understand this.
Over the years, I’ve watched supposedly brilliant engineers, doctors, and lawyers get wrecked (consistently), while old homemaker widows who hardly pay attention become millionaires. If you want to succeed, the first lesson is simple: Learn to be introspective. To help you get started down that path, I’ve listed the nine biggest humiliations to watch out for. As a bonus, recognizing these same biases in your daily living will make you a better human – a bit less lunatic and a bit more logical.
1st Humiliation: Loss Aversion
Since 1926, the stock market has been going up about 74% of all calendar years; far more than it goes down. Hell, no one would invest in the stock market if it didn’t. Yet, without fail, naive investors prioritize worrying about the downside. So much so, that to protect themselves from said eventual downside, they’ll willingly sacrifice all the upside in the interim!
This foolish behavior is known as “loss aversion.” It’s very well studied and has shown humans feel loss more than twice as much as they appreciate any gains. And not only does this loss aversion prevent investors from realizing the full potential of the markets over long periods, it tricks them into thinking stupid ideas like selling low is the intelligent thing to do to protect themselves from “further loss,” while the cold reality is the stock market has never and will never fail permanently. It’s simply far too important to our societal well-being for us to collectively allow it to fail – the US government bailouts in 2008 were a testament to that. So bulls, bears, why care? Over long periods, the stock market is incredibly reliable.
2nd Humiliation: Overconfidence
Engineers think because they figured out college physics, they can figure out the stock market.
Haha… nope!
Lots of folks, not just engineers, think they can self-manage their investments. They do their research online and develop these theories about investing – what’s right, what’s wrong, and what they should avoid. Then they financially commit their life savings.
An investor who behaves this way is exactly the same in principle as mysteriously bleeding from your eyes for two days, going online to figure out what’s happening, reading about the miracle remedy of “boiled pinecones,” and using that to treat your bleeding eyeballs instead of going to a hospital.
Ridiculous!!
You think you can reliably figure out one of the most complex subjects in human history, the stock market, by reading about it online in your spare time? Get real. You don’t represent yourself in court, you hire an attorney. You don’t diagnose your bleeding eyeballs, you hire a doctor. You don’t manage your own investments, you hire an investment professional (who’s had years of training and formal education, unlike you).
“Overconfidence” (pride) is extremely toxic to your financial future. Have the humility to admit what you don’t know or you’ll suffer the consequences.
3rd Humiliation: Confirmation Bias
As I covered in a previous post, “confirmation bias” is the idea that folks dismiss or neglect information that doesn’t conform to their existing beliefs. The stock market is famously good at screwing people who bring these random, often financially-unrelated beliefs to the table.
For example, here’s a (real) list of what people have said to me recently:
- “[Insert political candidate] lost and things are about to go to hell, should I get out of the market?”
- “I think we’re about to see a big drop – didn’t you see what came out of the Fed?”
- “I don’t like [insert social justice warrior topic], I want to get it out of my portfolio.”
- “Foreign companies are doing so much better than the USA, shouldn’t we buy all foreign?”
- “My neighbor made so much money with Bitcoin, why aren’t we invested in it?”
All of the above is textbook confirmation bias: Folks bring a belief they have to me, then seek confirmation of it. In these particular cases they want permission to act on said bias. A big part of my day job is managing this bias and tactfully telling people “no,” or at a minimum educating them on what’s really happening psychologically with some needed perspective.
4th Humiliation: Recency Bias & Serial Correlation
Stocks famously have zero ”serial correlation,” which is the idea that what happened previously in a sequence will impact what happens next. For example, say a stock went down for the past five months. Think it has momentum in that direction and will probably keep going down? Then you’d be wrong! Even if it went down for the past five years, that still means precisely nothing about it’s future.
Stocks are simply impossible to consistently predict over short periods. Anyone saying otherwise is trying to sell you something.
Countless times, I’ve counseled people against trying to time the market over short periods. Stocks are about future expectations, not what happened in the past. And those expectations change unpredictably because events themselves emerge unpredictably. Because of this fact, no one has ever consistently timed the market based on any form of public available data (and no one ever will, because time machines are impossible).
5th Humiliation: Anchoring
Retirees are frequently guilty of this: “Aaron, I need 1 million dollars to retire.”
No, not how it works. You need an investment plan capable of meeting your annual income needs and financial goals while still growing – your average annual return (AAR) must be greater than your overall annual withdrawal rate to prevent depleting your assets. That’s it. Whether that translates to $1 million or $3,543,215.56 is irrelevant.
People approaching retirement often get these “1 million dollars and I can retire” ideas, which is known as “anchoring.” It’s very dangerous thinking, because it’s based on essentially nothing. Say you cross $1 million. Feel better? Relaxed? Gave your notice and retired?
Sorry, but I’ve got bad news for you: You actually needed closer to $2 million to retire and you need to get your job back or you’ll wind up homeless by the time you’re 75. They won’t rehire you? Can’t find another job because you’re too old? Aw shucks, well you probably shouldn’t make life-altering decisions based on gut feelings backed by nothing.
Brutal.
During my tenure in the industry, I’ve striven to be a positive force in the Universe by fighting to prevent people from working their asses off their entire careers, only to blow up their retirement plan by mistiming it. Being old and broke is a terrible thing.
6th Humiliation: Hindsight Bias
Hindsight bias is all about the “should have known better” factor. Often, when looking backwards in time, we think events were more predictable than they actually were. This happens psychologically because our memories of those events get blended together; we’re not able to reliably draw distinct mental boundaries between what was known vs. unknown at the time of said event, so our brains end up subconsciously mixing them up. The result of this flawed memory recall is “hindsight bias.”
Examples:
- “You should have known about COVID19, 2008, etc.”
- “If only I had bought that stock!” or “If only I had sold!” or “I’m kicking myself”
Hindsight bias often leads to overconfidence or knee-jerk reactions in the future. It’s a sort of pseudo-confidence not based on any practical ability or informational edge a person has, yet will still add an underlying emotional charge to their future decision-making. So the next time they are faced with a panic, they will be more likely to act.
As they say, “hindsight is 20/20.”
7th Humiliation: Media Bias and the Bandwagon Effect
As you know, humans are very social animals: If a group of humans suddenly run in one direction, you can bet your life savings you will feel a noticeable pull to go in that same direction. This is completely normal and represents one of our survival instincts – biologically, we can generally trust our own species. So when they react to something, it’s statistically safest to mirror that action immediately rather than think about it first (i.e., don’t think about running from a predator, run from the damn predator!).
“Media bias” is a catch-all term that describes many different related biases. But concerning the stock market, it’s primarily the influencing factor that causes a population to surge in one direction or another – supply or demand. So if everyone’s buying or selling a stock, an individual will naturally feel an instinct to do the same.
Unfortunately, media outlets are no longer objective (were they ever, really?). This means they have a following of people who are directly influenced to action by what gets published. Then, “because everyone thinks that” or “because everyone’s doing it” people end up doing things they eventually regret. The classic scenario is a stock market panic – the crowd sells so I should too, right?
Wrong. So, so wrong…
8th Humiliation: Tribalism Bias
Particularly in 2020, we saw extreme polarization in the United States. I’ve written about tribalism in politics and the exacerbating effects of the media; both are becoming a significant problem in many countries. In the stock market, the effect is simple – “my tribe isn’t in power, so the world must be ending” or “that country is full of socialists, I don’t want anything to do with them.”
People with these mentalities typically like to “punish” tribes outside of their own for whatever reason by selling those positions. This is idiotic of course, as selling a position simply means someone else will happily buy it for a lower price, you only ended up hurting yourself, and no one actually got punished. Yet, people still do it.
The reality is a globally diversified portfolio provides the best risk/return characteristics, so every time you act xenophobically, you hurt your own financial well-being.
Tribalism simply doesn’t work in the stock market.
9th Humiliation: Emotional Imbecility
I often get these emotionally-stunted, data-cruncher types thinking the stock market is a math equation. That anyone could think the stock market, which is entirely composed of humans, is predictable mathematically is very telling: It shows that person is disconnected with their own emotions and the emotions of others; an emotional imbecile. For only an emotional imbecile would think the stock market is anything but a gigantic clusterfuck of chaotic, boiling, frothing, unpredictable human emotion.
You can’t predict chaos, by definition.
This is a classic cultural myth about Wall Street – that it’s the hyper-genius savant types who make the big bucks. Not true. Not true at all. In reality, emotional intelligence and emotional competence are by far the most important aspects of building wealth. If you don’t know how humans work, you simply aren’t going to make money off them! So stop working on your IQ and build up that EQ.
To conclude here, you should know that the above list really only scratches the surface. These days, professional investment analysis requires a mandatory understanding of hundreds of biases and how they can creep inside analyses to degrade the integrity of investment decisions. The study of behavioral finance is no joke – it’s central to all forms of commerce and if you care about being a good investor (or a good person, really), it’s critical that you understand your own limitations and biases.
This website is for general informational and educational purposes only and is not intended to constitute investment advice. I am not your financial professional and thus the information presented is general in nature and not tailored to your unique circumstances. If you need personal investment advice, seek out a licensed investment professional.