Over the years, I have noticed that it is most often the pessimistic scenarios that capture the attention of investors.
First, I believe that the psychological bias of loss aversion is particularly ingrained in investors. Loss aversion occurs when an investor prefers to avoid losing money even if it means leaving potential gains on the table. However, this desire to avoid losses encourages investors to pay more attention to pessimistic statements that could lead to a decline in the value of their portfolio.
Second, I believe pessimism is much more alluring to investors. In his book The Psychology of Money, the author, Morgan Housel, explains this point well. Pessimism is intellectually captivating, and it sounds smarter than optimism. According to him, optimism sounds like a sales pitch while pessimism sounds like someone trying to help you. I believe he is right! Imagine I’m telling you about a stock that could double in the next few years. Your reflex may possibly be to doubt my words. You may say to yourself, “Why is he trying to sell me this stock?” Conversely, imagine me presenting you with my doomsday economic outlook scenario where a sharp fall in stock markets is more than likely. Your instinct may be to thank me for letting you know.
Third, extreme scenarios are attractive to the media. What do you think will attract the most ratings and clicks? An expert who predicts the apocalypse or a moderate expert?
One of the problems with pessimistic opinions is that they often focus on a short period. For example, the economy is expected to go through difficult times over the next two to three years. Unfortunately, this perspective runs counter to a long-term investment strategy. Why try to avoid a market decline when you plan to be invested for more than ten years?
Are you retired and your investment horizon is only a few years? Your asset allocation should be adjusted according to your investment horizon and not according to pessimistic or optimistic forecasts.
Moreover, acting on these forecasts involves making several decisions. When should we sell? When should we buy again? What to do if the correction does not come or its magnitude is not what was expected? The more decisions you have to make, the more the level of complexity increases and the more you risk making mistakes and reducing your long-term returns.
Note that I am not saying that the forecasts of the pessimists are necessarily wrong. On the contrary, some of these “prophets of doom” have coherent statements. However, we must understand and accept that economic crises and recessions are part of reality. While certainly unpleasant, recessions are still normal, temporary, and even healthy for the economy. Since we cannot escape recessions, these experts will, sooner or later, be right. However, the truth is that no one can predict the future or the precise moment when events will occur. The world is not white or black. There are a multitude of shades of grey in between.
A stock market investor cannot control the short-term movements of the market. However, he can exercise complete control over the choice of companies that make up his portfolio. Control what you can control. Above all, do not change your investment strategy based on short-term pessimistic or optimistic forecasts.
Jean-Philippe Legault, CFA
Financial Analyst
