Financial Geekery

your own worst enemy

September 11, 2012

 There are two stories that I am tired of hearing.

 

One is a story of greed. I heard it a lot around the turn of the century, and again just before the 2008 crash. It took many forms: day-trading with a 401(k); dumping Oracle stock for that of a smaller company because the database giant was “only” scheduled to double; after some clever analysis, placing a disproportional bet on muni bonds. In every case, the portfolio in question became dangerously out of balance, and when the inevitable crash came, it lost far more than its share. In the cases where its owner was approaching retirement, the impact was disastrous.

 

The other is a story of fear, and I’m hearing it a lot now.  Retirees whose entire portfolio is in cash, and pre-retirees who are considering not bothering with their 401(k) anymore — because it seems that no matter how much they put in, the balance stays the same or goes down.

 

Of course, neither of these stories has a happy ending — they’re the source of the Behavior Gap that Carl Richards is so fond of talking about. It’s easy to blame them on fear or greed, but that’s really only part of the story. A more sinister villain is also at play here: recency bias, the well-known tendency of humans to believe — irrationally! — that things are going to stay the way they are, whether good or bad. In 1999, everyone knew that tech stocks were going to continue to go through the roof; in 2006, everyone knew that real estate was a sure bet; in 2008, everyone knew that the stock market was going to plummet forever. (You might ask yourself: what does everyone know now?)

 

Recency bias is a powerful enemy, though. It masks itself as rational behavior — why keep my money in bonds when stocks are going to continue to outperform? Why keep my money in stocks when they’re going to continue to remain volatile? And in our effort to stay informed, we expose ourselves to an amplification effect from the financial media (whose job, recall, is not to give us unbiased information, but to sell copy) that barrages us with provocative headlines like “Are Stocks Dead?” and “Is This The New Normal?” It’s enough to make even the most rational investor bail out (or jump in, as the case may be).

 

So what’s a poor human to do? Well, you know my answer: systems. In the case of investing and saving for retirement, there are some handy weapons in your arsenal for dealing with your own worst enemy (yourself); stay tuned for next week’s post, when I’ll introduce you to some of them!

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