Paper Losses

 In Books, Fred's Blog, Money, People, Transitions, Uncategorized

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.

 

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Showing 19 comments
  • Avatar
    Sam
    Reply

    Puritans having “swallowed gyroscopes” – what an eloquent way to describe serenity on life’s pitching seas. A goal towards which I aspire. And the gyroscope is the unwavering Truth found in the Gospel and in our Savior and GOD.
    Thanks, Fred.

    • Fred Smith
      Fred Smith
      Reply

      Thank you, Sam. It is for sure a vivid image that I heard 30 years ago for the first time and have never forgotten. I asked Os Guinness about it yesterday and he said the original is from David Riesman who worked for Sperry Gyroscopes. He said some people have internal gyroscopes and are internally directed while others use radar which responds to what is around you. I think it has all sorts of applications.

  • Avatar
    Jack Modesett
    Reply

    You’ve heard your dad tell of Maxey Jarman having lost a lot of money after a lifetime of generous giving. When he asked Jarman if he regretted not keeping more wealth for himself, he responded, “No. The only money I lost was the money I kept.”

    • Fred Smith
      Fred Smith
      Reply

      And then there is the story of the man who wanted to make a memorial gift for his friend and put a check for $20,000 in the casket.

  • Avatar
    David
    Reply

    Probably my favorite quote from brother Os.

    • Fred Smith
      Fred Smith
      Reply

      Mine as well. But there are so many from Os!

  • Avatar
    Michael Harrison
    Reply

    Appreciate the blog & your keen insight Fred. As a Financial Advisor, it’s human nature to be concerned about the future, and doom-and-gloom headlines commence attention in both good & bad times. Emotions can lead to irrational decision making. The important thing is to have a well-informed understanding of how much risk you can tolerate by seeking the guidance of a trusted Financial Professional.

    • Fred Smith
      Fred Smith
      Reply

      I would imagine you see “loss aversion” quite a bit! It does help to have someone with a longer perspective alongside.

  • Avatar
    Don Wills
    Reply

    Great …. very interesting and applicable to more than investing. Keep em coming

    • Fred Smith
      Fred Smith
      Reply

      Thank you, Don. Yes, I was thinking the same thing.

  • Avatar
    Howard
    Reply

    All I can say is, charities and politicians, Christian and not, sure want us to do our giving decisions in the fast mode!

    • Fred Smith
      Fred Smith
      Reply

      Everyone knows that urgency and crisis raise more money than incremental change.

  • Avatar
    Howard
    Reply

    There was a famous book back in 1950 called The Lonely Crowd that spoke of how American culture was shifting from “inner directed” I e gyroscope to “other directed” I e radar.

    • Fred Smith
      Fred Smith
      Reply

      The co-author, Nathan Glazer, died yesterday. I had ordered the book earlier and spent part of this morning reading it. While not quite Tocqueville, they were certainly on to something growing in the 50’s.

  • Avatar
    Lisa Wen
    Reply

    Thank you, Fred….your thoughts remind me of Ecclesiastes 3:1..”To everything there is a season, and a time to every purpose under heaven.”
    The stock market has historically, as you know, gone through cycles of correction, and now, perhaps unprecedented volatility from political events and the ability of any investor to go online and execute transactions. Although it has not been pleasant for me to see what has been happening to my portfolio this past year, it has been a time of surrender and trust in our Lord’s goodness (Jer 29:11-13), His Faithfulness, and asking myself….”What is my identity rooted in?” “Am I giving to satisfy my own ideal of my identity, or in response and obedience to the Holy Spirit?” So grateful for your thoughts:). What do you think about inviting Bob Doll to speak again in September?

    • Fred Smith
      Fred Smith
      Reply

      Thank you, Lisa. It is hard to stay the course while you see the market respond irrationally to every little bit of news and rumor. I suppose it has always been so. Still, this time feels different.

      • Avatar
        Lisa
        Reply

        Yes…it does feel different. My financial advisor, who is a believer, tells me that fundamental changes in the structure of stock market investing (such as the ability of any investor to go online and make trades) has shifted a key factor affecting the stock market. Individual investors who do not rely on financial professionals are generally more driven by their fears and emotions rather than thinking through matters more rationally with a longer term perspective. I’m not sure what this all will mean, other than the likelihood that we will see greater volatility in the markets than we have seen in the past. Well, I suppose that this has led me to surrender and trust more in the Lord’s provision and guidance in my giving….

        Do you think it would be a good idea to ask some financial professionals such as Bob Doll to speak in Sept, or do you think that that would be putting them on the spot too much?

        • Fred Smith
          Fred Smith
          Reply

          With 85% (or more) of all trading being done now by machines and artificial intelligence it is hard to know what is driving the market. However, I am losing my confidence that it is as rational as it might have been once.

        • Fred Smith
          Fred Smith
          Reply

          We’ve had Bob speak about global financial trends but when financial professionals get in front of a Gathering crowd it is hard for them to restrain themselves from selling their services or their firm’s approach to investing.

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