My Dangerously Selective Memory

Lately I have been doing something that you might think is a bit odd. I have been forcing myself to re-live and hold on to painful or unpleasant memories. As an investor, I think you should too, and here’s why.

Among the many strange things our brains do is something called the “fading affect bias.”  Basically, we aren’t very good at remembering negative emotions. Our brains shrink the memories of bad times, painful experiences and anything generally unpleasant. My favorite example of this comes from my wife.

My wife has been a distance runner since college. Many years ago I had tagged along to support her on one of her first marathons (I was not running, mind you!). At about mile 23 she looked me dead in the eye and said “NEVER let me do this again.  I hate this.”  I can attest that she was serious and not particularly enjoying herself at that moment. But I don’t think it was a week later that she was looking at race calendars and training programs and thinking about what would come next. Her brain had minimized the unpleasant feeling of running for four hours and tipped the scales in favor of another race.

Of course, many mothers share similar stories about childbirth. From an evolutionary perspective, the fading affect bias makes perfect sense. Why would you willingly go through such torment if you fully held on to the memory? If not for this bias we may not have made it as a species.

After a decade or so of working with investors, I can tell you that we carry this bias into our portfolios as well, and it is a dangerous thing.  There are two main ways I’ve seen this bias lead investors astray.

For one, the fading affect bias (and its cousin, optimism bias) promotes gambling and speculation. Imagine you speculate on a high-flying small cap biotech and it gets wiped out. If you sufficiently held on to the pain of that past loss, you might be discouraged from such foolishness again in the future. But when your biases kick in, you could be tempted to minimize the pain of that experience and allow yourself to be distracted by pleasant memories of your occasional winning gamble. And so you’re at the table again, looking for the next big payout.

But the real danger for most long-term investors is minimizing past bear markets. In the moment, bear markets can be terrifying. When the bear comes, there is always some major economic or geopolitical event pushing stocks into a tailspin. Even the “little” hiccups we’ve seen in the past few years had real roots. Was Russia really invading the Ukraine? Was the ebola virus really in the US already? Is it all over for China’s economic growth? These stories and the accompanying down days in the markets can raise our blood pressure and make our mental palms sweaty. We worry – how bad can this get?

And then, a month later, we laugh at ourselves. It was nothing, we say. It seems so obvious in hindsight that it would turn into just a brief downtick in our portfolios. But that’s not how we treat the next one. The next one seems real. Those little events of the past, sure, they were no big deal. But tomorrow’s news? Tomorrow’s news is different. Tomorrow’s news is scary. Tomorrow’s news could be the big one.

Your homework today is to spend some time forcing yourself to remember being scared about the markets. Force yourself to relive the anxiety and worry of being down 5% and wondering if 20% is coming next. Remember what it was like to worry that war might break out or disease was spreading or economic collapse was around the corner. Not because this alone is a good practice, but because it is going to happen again, and sooner than you think. It happens every year like clockwork. You can’t pick a time in history that something scary wasn’t around the corner. You need to hold on to those past moment and then recognize that even though it was truly scary life moved on and markets recovered and the world didn’t, in fact, come to an end. So that when next time the fear comes, you think “this is scary and unpleasant and a little awful, and it was last time too!” Then you can remember that the fear this time only feels different. It isn’t truly different.

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