Listen to “Paper Losses” by Fred Smith
Several years ago I read an article using the research of Daniel Kahneman and Amos Twersky to illustrate the brain’s reaction to gain and loss. It seems the amount of pleasure we receive from a gain of $1000 is not equal to the amount of sadness we feel about a loss of the same amount. In fact, according to their findings, we are two times as sensitive to loss as we are to gain, and it would take a $2,000 gain to offset the pain of our $1,000 loss. Our capacity for regret seems to outpace our capacity for happiness by at least twice.
The article went on to suggest applications for investing. Some of us will hang on to a losing investment out of “loss aversion” and hope it will somehow come back to the level at which we bought it. It’s easy to believe the stock remembers our purchase price and is working to get there again so we can sell. Unfortunately, equities do not have memories. Others will abruptly sell stock that has gained value wanting to feel the concrete but momentary pleasure of making a bit of money and, as well, avoiding the risk of somehow losing their profit.
Training yourself to take the loss and then invest in something with the potential for gain seems to be going against a hard-wired bias. It is difficult absorbing the pain of the loss and at the same time focusing on a future gain. The best investors I know understand the value of accepting a loss and focusing their attention on new opportunities.
You may be thinking I’m going to find some spiritual or moral lesson in this. I’m not. But I’ve been watching my own emotions as well as those of people around me as they react to the substantial losses we have been experiencing over the last several weeks. Years of appreciation are being vaporized in a few days.
Some are giving in to panic. In “Thinking Fast and Slow” Daniel Kahneman describes “Two System” thinking. System 1 is thinking fast and that is where we spend most of our time. It is our gut reaction for responding to changes and making decisions that are based on impressions, memories, limited information, and intuition. The result is jumping to conclusions, short-sightedness, and searching for a quick solution.
Some are sitting on the sideline anticipating buying opportunities at the bottom. Unfortunately, it is impossible to know for sure when markets have hit highs or lows. Princeton finance professor and author of “A Random Walk Down Wall Street” Burton Malkiel calls it a “fool’s errand” and he is right. Likely, more money has been made selling prediction theories than identifying opportunities. In the end, investing is a game of chance according to Kahneman. After 50 years of research, Kahneman points out that “the selection of stocks is more like rolling the dice than like playing poker.”
Some are totally immobilized or angry and looking for someone (Trump, China, Federal Reserve, or algorithms) to blame. One of the symptoms of System 1 thinking is susceptibility to simplistic answers and dark conspiracy theories. Our brains want to identify causes and coherent stories. We don’t like ambiguity or complexity. This is why we so often jump to conclusions, assume bad intentions, and give in to prejudices. It is why so much “fake news” is spread by people looking for villains, bad actors, and information that confirms their existing bias.
Some have gone to bed “rich” and awakened to a market that has made them “not rich” and that’s a tough pill to swallow. When being rich becomes a part of our identity instead of a measure of assets we suffer more than a financial loss. In a blog last year I described the effect of gold kryptonite on Superman. “While green kryptonite is the one most often associated with the enemies of Superman, there was one that had a very special and humiliating effect. It was gold kryptonite. While not fatal, it reduced Superman to a normal human with no superpowers at all. No leaping over tall buildings at a single bound. No stopping a speeding bullet. No big-league philanthropy. That is exactly how it can feel when you are accustomed to doing “superhuman” things. It’s not only the loss of the money but the loss of the power and agency.”
Some are wishing they would have given away more and secretly thinking God might have then limited their losses.
Others are just dealing with it and not letting their paper losses do any more damage to their sense of values than the paper gains did to their identity. Neither gain nor loss has changed them. Os Guinness says about the Puritans, “It is as if they had swallowed gyroscopes.” That’s what I want to feel more than mere happiness or the impossible avoidance of loss.