“Politicians have the same occupational hazard as generals – focusing on the last battle and overreacting to that.”
I used to be a news junkie. I worked at home, and rather than have silence or a useful background noise like soothing music or the sound of howling wolves played on a repeat loop, I kept the television tuned to cable news (to read more about whether or not you’re addicted to news you can’t act on, you can subscribe to my free newsletter).
In 2008, the market was in the throes of decline as the United States went through a recession. Every other news segment had something to do with the end of the world as we Americans knew it and how the market was going to crash and collapse.
Even though it was in the background and I didn’t think I was paying attention, I was. Actually, my prefrontal cortex, the part of the brain that controls rational thought and our conceptions of the future, wasn’t really paying attention, but Monkey Brain, my limbic system, was tuned in. The more he heard about the woes of the economy, the closer he got to pushing the panic button.
Eventually, I caved in. Rather than staying the course and remaining invested, I convinced my wife to pull out a bunch of our investments and buy a house instead.
I may not be great at market timing, but I’m pretty darn good at picking a bottom to withdraw money. The market proceeded to start an inexorable climb back, as if everyone in the world had been sitting on the sidelines waiting for my capitulation to signal that it was time to pour money back into the market.
Monkey Brain refused, naturally, to look at the evidence of the rising market to admit that perhaps we’d not made the best possible investment decision. We’d bought a paid-off investment property that was providing us with a rent check every month, but I had the nagging fear that I’d been a little trigger happy when it came to selling our market investments.
Monkey Brain won the battle because every time I thought about actually running the numbers to see which investment decision was better, he distracted me with shiny objects. I felt like Jeremy in The Secret of NIMH trying to impress Mrs. Frisby.
You’d think that the little nagging feeling would have been a signal to me that something was wrong. It wasn’t.
Fast forward to July 31, 2011. Washington D.C. and the news media were up in a lather about a debt ceiling debate. We were going to hit the debt ceiling, default on some payment somewhere, and get downgraded. I figured the market had nowhere to go but down, as if I had some mole inside of the Beltway whispering about blackmail pictures to every member of Congress and the White House. Even though I had no true insider knowledge about what was going on behind closed doors and in smoky rooms, Standard and Poors downgraded U.S. debt, and the market dropped.
I was vindicated!
“I’m so glad we’re out of the market,” I’d message my wife.
There was one problem. I was right on one side of the trade, but I had absolutely no idea when to get back in.
In order for a trade like that to work, you have to be right not just once, but twice. In effect, you’re trying to call a top and a bottom for that event.
Oh boy, did Monkey Brain have fun playing with that one. Suddenly, we had a pile of cash sitting on the sidelines. I knew that, over time, inflation would decimate the purchasing power of that money and it needed to be invested in something which would beat inflation over time.
But when to get back in? Um…
Whenever I’d start to contemplate getting back into the market, Monkey Brain would start throwing those “what if” questions at me that I couldn’t answer.
I finally gave in and did what any prudent investor with a sum of money should probably do – value cost averaged. The issue was that I should have never created that pile of money in the first place, as most of it wound up on the sidelines when the market recovered. Dumb (2008) and Dumberer (2011).
If this describes you, you’re not alone. Not only do you have me for company, you have a ton of ordinary investors. According to a report by Standard and Poor’s, Americans who fled the markets wound up missing out on $200 billion in gains. Unless you work for the U.S. government, that is a staggering number.
Why does Monkey Brain keep telling you to get out of the market at the wrong time?
- The Dunning-Kruger effect. I’ve previously covered how the Dunning-Kruger Effect keeps Monkey Brain from solving the annuity puzzle. It’s a psychological bias that makes you think that you’re smarter than you are. In this case, you listen to the news about the Great Recession, debt ceiling, fiscal cliff, or topic du jour, and you think that you’re going to outwit everyone and get in and get out at the right time (for a related article, see my U.S. News & World Report article “How Herd Behavior Hurts Fund investors”).
- Recency bias. In this case, I chose to look at the rent checks we were getting as our alternative investment and refused to look at the opportunity cost that I’d inflicted on us by not remaining in the market. I chose the one outcome which was positive for us rather than looking at the choices in their entirety to determine if I’d made the right decision.
- Mental accounting. By investing in a rental property, I mentally shifted that money into the “rental property” mental account. Since there was no longer money in the “market investment” mental account, I didn’t feel like I had to figure out the opportunity cost. In my mental accounts, I was comparing apples and oranges. In reality, I wasn’t. Money is money; it’s not fungible. Money in a “market investment” account can’t buy more or less of something than the money in the “rental property” account can.
You can be aware of all of this and still get an itchy trigger finger. I did when the U.S. faced the debt ceiling. What are some things you can do to keep Monkey Brain from issuing sell orders on your trading platform?
- Have a regular plan for saving. If you’re regularly setting aside money for saving and investing, then you won’t be as worried about missing out on opportunities. There’s always another one right around the corner.
- Value cost average. Don’t tempt yourself into thinking that you can time the market. Pick a set time every month and value cost average.
- Know your time horizon. Our time horizon is still a few years out. It wasn’t like we was on the verge of retirement and needed to consider annuitization. We still had a lot of time and plenty of runway to survive the vicissitudes of the market.
- Get a plan and stick to it. Your retirement plan shouldn’t hinge on hitting a seven run home run. It should be a structured, disciplined, periodic plan that involves process and forethought, not swaying whichever way the news media makes the wind blow. It’ll enable you to turn off the TV, stop watching the news you can’t act on, and sleep well at night. Sleep well at night, and you’ll be a lot healthier and happier with yourself.
I’m now twice bitten, thrice shy. No more overreacting to news and letting it affect our retirement planning. Plus, the next time I get some harebrained investing idea, my wife knows better than to allow my Monkey Brain to sway her.