Hey everyone and welcome to another weekly recap post for September 25, 2020. This is a thought piece on how we think about investing. In every market crash, investors are often forced to reflect on their investing style and some even try to shift their approach completely. Are you one of those people? Let’s talk about it.
But first, my disclaimer: this post contains affiliate links where the blog may receive a small commission on any sales from Silver Gold Bull, EQ Bank, Questrade and Tangerine.
Markets Correct, Deal With It
In every market crash, people always ask themselves if there was another approach that would have performed better. These are normal feelings that we all have of course.
But I found the best approach, over the long term, is to stay diversified and stick with your original plan. Here’s why.
We are Really, Really Bad At Predicting the Future
When dramatic events happen (ie. a Banking Crisis, War, Terrorism, or a once in a lifetime pandemic), people always fall into the trap that the future is now forever changed.
Recency Bias
Psychologists call this “recency bias” where we believe the most recent events are likely to continue in the future.
We fall victim to these assumptions and, if we act on them and make changes to our investments, we could make big mistakes and lose lots of money.
Just think about all the craziness out there today and what people are saying about the future.
Right now, people believe that they’ll work from home forever. That’s just not gonna happen, wait and see.
Also, we will be going on vacations again, maybe even sooner than we think. So we will fly, take cruises, stay in hotels, eat at restaurants etc.
Global prosperity relies heavily on available cheap energy and we are nowhere near going off oil and other fossil fuels despite advancements in clean , green energy.
And, finally, our cities will once again become centers of social and economic life.
Group Think
Investors also fall victim to group think. This is happens, for example, when investment analysts try to conform to their peer group.
That’s why we get buy and sell ratings on stocks that are basically all in line within a given range. No one wants to the be lone wolf and make a bold call.
Herd Mentality
The herd mentality is responsible for bubbles which often lead unwitting investors straight off a cliff. This is when investors are guided more by their emotions rather than rational thinking. It’s the whole fear and greed thing.
We recently saw both of these emotions at work this year. We saw a dramatic example of fear take hold in March when we experienced a major sell off. And we saw a stunning example of investor greed over the summer in the tech sector that lead the recovery.
These are just some of the the more common reasons that investors get things wrong. All too often, we recognize all of these biases in hindsight. Its only after the bubble pops that we see that there was a bubble to begin with.
What About Taking The Opposite View
It’s really hard to take go against the herd. After all, sometimes the herd is right.
I think we have difficulty going against the herd because of our own fear and self doubt. This is the whole “what if I’m wrong” way of thinking. This type of thinking leads to paralysis where we fail to take any action at all and results in missed opportunities.
Some of the most successful investors by far are contrarians. They buy low and sell high. Sometimes they make investments that don’t make sense at the time but hold future promise.
I think having strong conviction is key to being a successful contrarian investor. Another key is to be well diversified so that you can withstand short term volatility and not get blown out of your position by margin calls.
The final key is to remember the old saying: “The market can remain irrational longer than you can remain solvent.”
But if we just blindly take the opposite view we may fall victim to another more serious bias known as the Dunning-Kruger effect.
Dunning-Kruger Effect
I’m sure we’ve all experienced this at some point in our lives and I bet it was a humbling experience.
The Dunning-Kruger effect describes a phenomenon where people believe that they are smarter and more capable than they really are. This leads them to overestimate their own abilities and vastly underestimate risk.
These people confuse luck with ability and can lead them down a path of taking greater and greater risks.
At some point it can blow up in their face and lead to catastrophic investment losses.
I think investors need to become more self-aware of their own limitations and weaknesses.
That’s where diversification comes in as an implicit acknowledgement of our own limitations about predicting an uncertain future.
Diversification Can Save Us from Ourselves
We are our own worst enemy when it comes to investing and money. By being properly diversified among different asset classes and rebalancing those positions when appropriate we can overcome our own limitations.
Unfortunately, most of us never rebalance. Instead we double down and commit new money to our best performers.
So for example, we buy tech stocks instead of REITs, energy and financials.
I think the best approach has always been owning the 5 major asset classes: Stocks (equities), Bonds, Cash, Real Estate, and Gold.
Save, Invest, Build Wealth and Prosper
In case you’re wondering here’s where I park my money and some financial services that I use:
For my precious metals I use Silver Gold Bull because they price match and offer fast, insured, delivery.
For my Daily banking I use Tangerine.
For my Savings I use the EQ Bank Savings Plus Account. Never heard of it? Click the link to check out my EQ Bank Savings Plus Account Review.
For investing I use a combination of TD Waterhouse (for legacy investments) and Questrade (low cost stock purchases and free ETF purchases). If you haven’t done so already, check out my Questrade Review to see why it’s the best deal around. Get $50 in Free Trades when you signup for Questrade through this link.