Are you a “glass is half full” or “glass is half empty” type? When it comes to investing, there is considerable room – and evidence – to believe that you’ll be better off if you assume a half-full outlook. So why do most investors seem to expect the worst as early and often as they can?
In his recent post, “Why Does Pessimism Sound So Smart?” Morgan Housel offers some excellent insights on how we tend to give pessimism more weight than it deserves. Most of the reasons he proposes come from our jungle instincts to err on the side of caution. He cites behavioural finance Nobel laureate Daniel Kahneman, who observes: “Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.” These are tough tendencies to overcome in markets that typically reward cooler heads.
The final reason Housel proposes is particularly interesting:
Pessimists extrapolate present trends without accounting for how reliably markets adapt.
In other words, a pessimist thinks the markets work something like this: “If [bad thing] happens, then [bad outcome] will occur.”
Instead, markets usually work more like this:
If [bad thing] happens, then banks, governments, society and/or businesses will swing into action and try to fix the damage done. [Bad outcome] may or may not occur. We may even end up stronger for having met the challenge.
In his article, “Avoid Investment Depression,” financial author Larry Swedroe refers to these lines of reasoning as “stage one” (pessimistic) versus “stage two” (optimistic) thinking. “[T]he greater the crisis, the greater the response is likely to be,” he observes, which explains why the markets have tended to adapt to bad news as Housel suggests, adjust as needed, and move onward and upward over time.
As such, without being blind to bad news, we have far more reason to believe that markets will continue to deliver solid returns to patient investors than to despair that they won’t. All in favor of optimism, raise your hand. You can count mine among them.