My last article was entitled "Pessimists sound smart, optimists make money".
Today I thought it might be worth looking in some detail at a number of the key structural reasons that pessimism can be so powerful. Whilst what follows may seem a little “off-piste” for someone ostensibly writing about investment and financial markets, I’d ask you to bear with me, if only because the points that follow are entirely relevant to your chances of building significant wealth – and to a fair bit else besides.
It is precisely because “pessimists sound smart” and pessimism is so powerful that too many of us fail to make the most out of investment. But I would go further and argue that the emotional and psychological power of pessimism has even more serious and negative consequences; Not only does it reduce the probability of financial success for untold millions of us, it can compromise mental health and negatively impact government policy. Pessimism and negative press bias have also been shown to be drivers of the increasing societal division, polarisation, and culture wars we’ve endured in recent years. It is a big part of the reason that society is becoming demonstrably ever more divided and divisive and why people are empirically less happy today than in the past, despite being infinitely better off materially.
My view is that we need an antidote to all of the above – if we want to become better investors, but, related to that and perhaps even more importantly, if we want to build better societies and the best future for all of us, as hyperbolic as that may sound. By understanding why pessimism is so powerful we can take the steps required to “immunise” ourselves against that reality: Forewarned is forearmed after all.
This is actually quite hard given it means swimming more or less aggressively against the tide and deciding to join a small and contrarian minority of the population, but my view is that it is more than worth the effort and I believe this stance is pretty robustly supported by the evidence.
I might add that my ultimate aim with this series over the next few weeks and months is to present an approach to investment which can do a really good job for anyone financially over a lifetime. Before we get to the specifics of how you might do that, however, it is worth looking at some of the reasons so many people fail to optimise their financial affairs. Understanding the role of pessimism and a prevailing negative press bias is a key step on that road. So here goes:
Pessimism and negative press bias...
As I said in my previous article, it is a well-established empirical fact that journalism has a very strong bias towards the negative and sensational and away from the positive and / or pedestrian.
I find this to be a very strange feature of the modern human condition when you actually stop and think about it for a moment – something it seems that too few of us do, sadly. A large percentage of the population all over the world will come home from work in the evening, slump in front of the television and choose to watch someone in a dark suit spend half an hour or so telling them about all of the utterly horrendous things that happened in the world today and pretty much only those horrendous things – most of which will have taken place thousands of miles away from where that person lives and more than likely bear no actual, tangible relevance to their day to day lives. Many people spend significant chunks of their time doing essentially the same thing on their smart phones as they go about their day. This is generally seen as entirely normal.
People think they are “informed” as a result of this behaviour. In fact, they are given a horrendously warped notion of the true state of the world and, by extension, of financial markets and investment too. This creates all sorts of second order problems for us as individuals and for society more generally.
Survey after survey finds that most of us in the developed world have a fundamentally gloomy and pessimistic outlook. For example:
“A 2015 survey asked “All things considered, do you think the world is getting better or worse, or neither getting better nor worse?”. In Sweden (only) 10% thought things are getting better, in the US … only 6%, and in Germany only 4%...”
These findings fly in the face of empirical reality and are pretty astonishing when you consider the truly extraordinary progress we have made as a species in the last few centuries as the Renaissance, agricultural, financial, scientific and industrial revolutions have lifted billions of us out of the grinding poverty, insecurity and awfulness of the Dark Ages.
Why is this the case?
There are a number of specific reasons people feel this way which are mostly to do with how our brains work. As Harvard Psychology Professor, Steven Pinker explains:
“Whether or not the world really is getting worse, the nature of news will interact with the nature of cognition to make us think that it is.”
The problem is that we human beings have some extraordinarily problematic “software” in our brains. Specifically, we suffer from a raft of unhelpful and powerful “cognitive biases” which took thousands of years to evolve.
Historically, these imperfect psychological biases kept us alive. In a world of scarce resources and where other human beings were more likely to inflict physical harm on you than not, it paid to expect the worst. It was a key survival mechanism. Sadly, our psychological software has not kept pace with our progress into an era that is factually incredibly abundant, leisured and peaceful for the significant majority of humanity – not something our brains are used to at all.
Specifically, our “reptilian" or "triune" brain causes us to suffer from three “cognitive biases” of particular relevance here: First, something which Nobel prize-winning psychologist Daniel Kahneman and his colleague Amos Tversky called the “availability heuristic”, secondly another closely related phenomenon known as “recency bias”, and thirdly an idea described variously as “the hedonic treadmill” or “hedonic adaptation”.
It is worth looking at each of them in turn given that it is only by understanding them that we can potentially put them in their place:
1. The availability heuristic...
The availability heuristic means that:
“…people estimate the probability of an event or the frequency of a kind of thing by the ease with which instances come to mind.”
In his excellent book "Stumbling on Happiness" another Harvard Professor, Daniel Gilbert, gives various examples of how we remember things that are out of the ordinary or exciting very significantly better than things that are ordinary or dull.
As a rather prosaic example, he cites a common belief that many of us hold; that we are somehow inherently doomed to always chose the slowest moving queue at the supermarket. Of course, this is statistically not the case. Each of us is factually just as likely to choose a fast-moving queue on any given day as we are to get stuck behind “…the bovine grandmother waving coupons…” at the cashier (his words, not mine).
As he says: “This doesn’t really happen that often, but because it is so memorable, we tend to think it does.” Standing in a queue that is moving quickly or at a perfectly normal pace is totally unremarkable and so we never remember all the times this happens. What we do remember is when…
“…the guy in the bright red hat who was originally standing behind us before he switched to the other queue has made it out of the store and into his car before we’ve even made it to the cash register…”
Another example of the “availability heuristic” at work occurs for many of us when we decide to buy a new car. Have you ever had that experience where you finally decide on the make and model of car you intend to buy and suddenly, as if by magic you see those particular cars absolutely everywhere?
You’ve never really noticed them before but now they are everywhere you look. Obviously, there is still the same statistical incidence of you encountering whichever model of car you have chosen on any given day, but it really is uncanny the extent to which you now notice them on every street corner as opposed to how essentially invisible they were to you previously. That is the availability heuristic at work.
Crucially, it impacts things which are rather more important than bovine grandmothers, fast-moving blokes in red hats or cars. From Steven Pinker again:
“News is about things that happen, not things that don’t happen. We never see a journalist saying to the camera, “I’m reporting live from a country where a war has not broken out”— or a city that has not been bombed, or a school that has not been shot up.”
“Every day the news is filled with stories about war, terrorism, crime, pollution, inequality, drug abuse and oppression… Plane crashes always make the news, but car crashes, which kill far more people, almost never do. Not surprisingly, many people have a fear of flying, but almost no one has a fear of driving. People rank tornadoes (which kill about 50 Americans a year) as a more common cause of death than asthma (which kills more than 4,000 Americans a year)… because tornadoes make for better television.”
The availability heuristic is powerful and makes too many of us feel that things are fundamentally worse than they are in reality.
2. Recency bias...
The availability heuristic is compounded still further by “recency bias”. This is the fact that our brains give far more focus and attention to things that have happened recently as against things that happened a long time ago or which may have happened gradually over a long period of time. This is another inherent brain malfunction which gives us a distorted view of reality. From Pinker again:
“Bad things … happen quickly, but good things aren’t built in a day, and as they unfold, they will be out of sync with the news cycle. … if a newspaper came out once every 50 years, it would not report half a century of celebrity gossip and political scandals. It would report momentous global changes such as the increase in life expectancy.”
As Bill Gates has put it: “…bad news is a headline, and gradual improvement is not”, or as former President Bill Clinton has said: “…follow the trendlines, not the headlines.”
We are programmed psychologically to pay far more attention to “newsworthy”, dramatic, negative things which have happened in the recent past and struggle to have any powerful or sufficiently emotive sense of far more positive bigger-picture changes that have taken many years to unfold. Those positive changes basically don’t make it into our consciousness at all, unless we make a decision to be proactive about going looking for them and to dwell on them when we find them!
3. The hedonic treadmill / hedonic adaptation...
All of the above contributes to a third cognitive bias or brain-malfunction; the “hedonic treadmill”. This is the established fact that, psychologically, human beings tend to assimilate things incredibly quickly, even really extraordinary and miraculous things, and then take them entirely for granted. This further reinforces our inability to factor really very significant positive changes into our idea of the world.
The Canadian clinical psychologist and author Jordan Peterson has suggested that it might be a good idea to…
“…compare yourself to who you were yesterday, not to someone else today…”
His argument is that this is a good thing for individuals to do in terms of their own personal mental health. I would argue that it is even more instructive (and fundamentally uplifting) to do this at the level of society as a whole.
Hedonic adaptation means that most of us don’t do this. A “new normal” which is actually a very significant, often even fundamental astonishing improvement on the past becomes very normal and very boring all too quickly and we all take it entirely for granted, whether that be running water and sanitation, electricity, warmth and shelter, abundant food, the ability to fly to the other side of the world, televised sport or smartphones.
This means that far too few of us realise just how much better everything is than it used to be - for the very significant majority of the human population, and as a statement of empirically verifiable fact irrespective of what “the news” happens to be bleating about today.
In 1820, it is estimated that roughly 90% of the world’s population lived in extreme poverty. Today that number is around 10%. In 1800, nearly 90% of people were illiterate. Today more than 85% of our species can read and the dividends this pays for empathy, cohesion, peace, education and human potential and progress are enormous. In 1800, more than 40% of children died before they reached their fifth birthday. Today only around 4% do, and that number is obviously significantly lower in the developed world and constantly improving in most of the developing world.
Average life expectancy has increased by several decades, in the main thanks to innovation from the healthcare and biotech industries and the role played by the adoption of rational science as an idea. The risk of dying in a war or of suffering from violence more generally has receded very significantly in most of the world even after accounting for the current crises in the Ukraine and Yemen. The list of extraordinary improvements is very long indeed but almost never explicitly celebrated, certainly not by traditional media and all too rarely on social media.
To be fair to us, there is a very good reason that our brains need to use “heuristics” such as the three cognitive biases outlined above. Heuristics are intellectual short-cuts which help us solve problems and make decisions.
It is now well established by several decades of scientific research that our day-to-day conscious experience of existence must necessarily be that tiny fraction of reality that our brain constructs on our behalf to make sense of everything. There are millions of potential data points available to our advanced human senses at any given moment in time. Even with the awesome computational power of our grey matter, our brain is programmed to edit and triage those data points to avoid our conscious selves experiencing madness-inducing overwhelm. We use heuristics to help us do that. In a very real sense we "make our own reality" as a result.
But the fact that we do is highly problematic and has serious consequences - if we permit our cognitive biases to dominate our thoughts and sense of the world at least.
Why this (really) matters...
When surveyed, most people think the world is significantly worse than it actually is based on any data-based empirical analysis. They think the economy is worse. They believe themselves to be unsafe and threatened by violence, crime or even terrorism and they’re more fearful of financial markets and investment than they should be.
“The consequences of negative news are themselves negative. Far from being better informed, heavy news watchers … become mis-calibrated. They worry more about crime, even when rates are falling, and sometimes they part company with reality altogether: a 2016 poll found that a large majority of Americans follow news about Isis closely, and 77% agreed that “Islamic militants operating in Syria and Iraq pose a serious threat to the existence or survival of the United States,” a belief that is nothing short of delusional…”
The sheer quantum of that delusion comes sharply into focus when you consider that, on average, considerably more Americans are killed annually by each of; insect stings, drowning in bathtubs, lawnmowers, peanut allergies, lightning, home appliances, “deer accidents” and even “armed toddlers” than by Islamic terrorists. This hasn’t prevented the 20-year “war on terror” since 9/11 costing an estimated $8 trillion and some way more than 900,000 lives.
In a democracy these fundamental malfunctions of human psychology, compounded by the inherent failings of how our media works have significant negative consequences:
First – they are bad for the development of government policy, because we live in democracies where governments care about and are invariably guided by public opinion when they make policy decisions, and arguably never more so than today when it is reasonably well understood that a generation of professional politicians tend to govern in response to poll results and focus groups rather than with any sense of proactive leadership born out of conviction.
They are also demonstrably bad for our mental health. There is solid evidence that our robustly negative press is at least partly to blame for the fact that more people than ever are fundamentally unhappy and stressed, notwithstanding how superior their material conditions are to most other human beings who have ever lived. It is one of the key drivers of mental illness, unhappiness, dissatisfaction and also, by extension, of conflict and division. As Pinker puts it:
“Consumers of negative news, not surprisingly, become glum: a recent literature review cited “misperception of risk, anxiety, lower mood levels, learned helplessness, contempt and hostility towards others…”
Of most relevance for our purposes, however, is the impact this reality can have on our ability to become wealthy - at the level of the individual and of society as a whole - and the far-reaching impact this has on the quality of all of our lives.
To be clear, in making this case I don’t want to appear too “Pollyannaish”. There are of course real problems in the world, but any concerted analysis of such things concludes that those problems get blown out of all proportion with negative consequences for all of us. Furthermore, for all sorts of reasons we could be doing a much better job at solving those problems were it not for our cognitive biases, our negative press and how both of these things impact our ability to make progress across the board.
In my next article, I will develop these arguments still further on the way to making some suggestions about how you might combat all of the above.