We should be buying now when the shares are cheap
Will we ever learn from our mistakes? Probably not. The stock exchanges went from a high-point in June 2007 to a low in March 2009, dropping about 50 percent in under 20 months.
2006 and 2007 Celebrations
We should have seen it coming, but most of us didn’t. In fact, most investors were too busy rejoicing, celebrating their Market wins in 2006 and 2007 to look around and see if they were about to careen off the cliff. We were taking and repaying Cash Advance Loans at a high rate of knots. All was well with the world.
It’s called overconfidence – the belief that you’re more skilled than you really are. That’s the reason we get ourselves into investment hot water. Overconfidence makes you unwilling to recognize bad news.
Overconfidence comes from early success
It happens to all of us who play on the market at some time. We buy some stocks. They go up. We sell and we’ve made money, all at the cost of a couple of phone calls and some broker’s fees. You then attribute all this to your own skill instead of the dumb luck it’s likely to be.
This spectacular operation of yours, on which you get good mileage at dinner, at lunch and in the locker room at the golf club, turns you into an instant stock genius.
The Accidental Investor
That tendency toward overconfidence gets magnified when it’s combined with our tendency to use past situations to evaluate risks in the here and now. Experiments have shown that when people risk their own money on an investment and succeed, they’re likely to take on even more risk the next time around. Why? They don’t think of that money as theirs. It feels like they’re playing with house money.
House money
Let’s say you put $1,000 into a share that triples; now that it is priced at $3,000, you’ve got $2,000 of “house money.” So long as any of that $2,000 gain is left, you may shrug off any losses as a reduction of the house money, rather than a depletion of your own.
Somehow, losing the house money hurts less than losing your “own”, even though, strictly speaking, all the dollars are the same. This highly dangerous “house-money effect” can egg you on into taking an ever-escalating series of risks until you get wiped out.
It Won’t Happen Overnight
If you want to beat the market, you have to battle your tendencies toward over-confidence and judge risks in relation to recent failures and successes. You can also compare your investment performance to market averages to help keep it contextualized. Finally you must develop an investing strategy to help you assess each risk on its own terms.
It takes years to become good at investing, to learn what information is important versus what is just noise, and to get over risk aversion and away from the idea of house money. Just like master carpenters are not made in a day, neither are master investors. But with patience and a little self-awareness, you can do it.
I bought today
I just couldn’t stand looking at all these bargains any more. I broke down and bought today. Let’s see what happens…
Most of the people who actually did see the market crash coming were silenced. There is a growing body of evidence that risk managers in Wall Street were warning their firms for years about all this derivative trading leading to failure, and a lot of bad side effects, but they were silenced (fired) because it was making a lot of money, which was assumed to be safe. In essence, these people were fired for doing their jobs, because preaching responsibility and sticking to making money the old fashioned way, i.e. selling a product or service for which there is a demand, would have meant effort on the part of huge multinationals to justify their existence.