We’re Not as Rational as We Think

Here is some investing truth: The reason so many investors get lousy market returns is because we let our biases influence our decisions.

It turns out that the human brain is a marvelous tool for so many things but is a terrible tool for investing.

Why? Because human beings make decisions based on our inherent biases about ourselves and the world around us – and not on the facts that really drive the market.

Over the last several days, I’ve been featuring essays by my friend Keith Kaplan.

Keith has been telling his story about the amazing tool he uses that has signaled every major market move over the last 20 years. And a lot of that success comes from taking human biases out of the decision making…

Please read the essay below and then join Keith and me for an exclusive event on June 23 at 4 p.m. ET, where we will show you how thousands of ordinary folks use this revolutionary tool with great success. I encourage you to join us.

Best regards,

Matt McCall
Editor, MoneyWire

We’re Not as Rational as We Think

As I mentioned earlier this week, people thought I was absolutely off my rocker for getting out of the markets on Feb. 28.

Who in their right mind would go to cash during a historic bull run?

I did, and as I shared, it was a good thing I did.

It took less than a month for the Dow to crash land into bear market territory — one of the fastest drawdowns we’ve seen in history.

By this point, everyone was so pessimistic about investing in the stock market that even talking about getting back in felt taboo. Many young investors got burned and long-time investors were licking their wounds, trying to recover from some really painful losses.

What’s actually crazy is that investors tend to hold onto their losers a lot longer than they do their winners. That doesn’t sound like it makes sense.

Anyone rational would say they would cut a loser and hold a winner, right?

On paper, that makes sense. But our human brains are emotional and don’t always stick to what’s perfectly logical.

We’re not walking, talking spreadsheets who can weigh all the evidence piece by piece, consider all possible risks and rewards, and do a cost-benefit analysis down to the last decimal point. We’re human beings, each with unique experiences and emotions.

Check out the chart below.

This Nobel-prize winning research shows that once our gains reach a certain level, the amount of happiness we feel towards those gains slows. Regardless of whether it’s a 100% or 200% gain, we feel about the same.

But losses are different.

As our losses increase, so too do our emotions. We might get more anxious or depressed, frantic to not lose our hard-earned money. Many people might even double down on their losers, desperate to get back to breakeven before they sell.

We’re more emotionally invested in our losers than we are our winners.

Behavioral economists look at how psychological, cognitive, emotional, cultural, and social factors impact our investing decisions. Everyone has flawed perceptions, and it’s not easy to control. In fact, certain cognitive biases can hurt your portfolio’s performance and even keep you from being a successful investor.

Take the confirmation bias, for example. This bias makes you favor information that confirms your previously held belief. For example, because you know Warren Buffett owns Apple and you have an iPhone, you might think Apple is a good trade. Whenever you see news articles praising Apple, you’re going to subconsciously favor that information. Anything talking negatively about Apple might get pushed to the back of your mind or even outright ignored.

The bad news is we all have biases like this and flawed perceptions. The good news is there are ways to overcome these biases — especially when it comes to our investment approach.

I told you that I got an alert in late February and went to cash. I also told you that I got another alert in late March and started to dip my toes back in the water. Both times, my emotions and cognitive biases told me it might be a bad decision. I was nervous and unsure about whether or not I was making the right decision.

Why? And more importantly, if I wasn’t sure about the decision, why did I move forward with it?

It comes down to behavior modification.

I just told you about how our brain’s wiring can keep us from making rational economic decisions. But with the use of science and technology, we can modify our brains.

Think about behavioral modification as someone who needs prescription eyeglasses. Without glasses, the world is fuzzy and unfocused. With glasses, everything is sharp and easy to see.

But for the patient’s vision to be fixed, both patient and optometrist need to identify that there’s a problem and come up with a solution. The patient can identify their blurred vision and the doctor can easily prescribe new glasses. Problem solved.

As I’ve said before, I’m no financial guru. I’m a regular guy. Because of that, I know that I need some help – some technology – to help me identify strong moves in the market and remove my own emotion. Problem identified.

My friends, colleagues, and the talking heads on the news were saying how bad the markets were and how crazy I’d be to get back into them. That made me uneasy. Another problem identified.

Luckily, I have unbiased, mathematical technology on my side. I saw a signal — unaffected by opinions and the nightly news —telling me that things might not be as bad as “the experts” were making them out to be — that things are going from bad to less bad.

When this signal has triggered in the past, good things have happened.

  • January 1991 – April 1994: Up 34.45%
  • May 2003 – August 2007: Up 50.71%
  • July 2009 – August 2015: Up 93.26%
  • April 2016 – February 2018: Up 26.05%
  • March 2019 – February 2020: Up 20.36%

With the Dow setting a record on March 9 for history’s largest point drop and two more record setting drops on March 12 and 16, getting bullish on stocks again felt impossible.

Not to mention, people were telling me that getting back in right now would be stupid.

But with this signal, I was able to act as a rational investor. I could put my fear, uncertainty, and doubt to the side. I didn’t need to worry about my flawed perceptions or any subconscious biases I might have. This signal and the technology behind it empowered me to make an informed decision on my trading strategy so that I could invest confidently once again.

To your investing success,

Keith Kaplan

Matt McCall’s MoneyLine Podcast

Click here to listen to Matt McCall’s MoneyLine podcast! This week, Matt talks about finding opportunities in the current market. It may seem like an impossible task, but they are out there. Matt shares his take on several analyst reports and talks about investing in innovation. And he also covers the latest COVID-19 situation and dives deep into what he believe is the sector of the decade. Get ready to take notes, because Matt is dropping tickers!

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