Excessive optimism can be an investor bias that may result in serious harm
Published Apr 21, 2023 • Last updated 4 days ago • 3 minute read
A trader on the floor at the New York Stock Exchange. Photo by TIMOTHY A. CLARY/AFP via Getty Images files By Julie Cazzin with John De Goey
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Access articles from across Canada with one account. Share your thoughts and join the conversation in the comments. Enjoy additional articles per month. Get email updates from your favourite authors. Q: I’ve been told by family and friends that when it comes to investing, my returns suffer because I’m too optimistic. I thought my returns were actually pretty good over the past few years. Is optimism a good or bad thing when investing? And can being an optimist really hurt my long-term returns? — Don
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FP Answers: I certainly agree that excessive optimism can be an investor bias that may result in serious harm. Ironically, it is usually the singular trait that offers the most benefits, too.
Individual optimism correlates strongly with happiness, longevity and the ability to withstand tough times. Most of the time, markets go up, so most of the time, optimism keeps people invested. Participating in that general tendency is usually quite positive.
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Article content But optimism can hurt when people don’t stay the course and end up selling before the market turns upward. There’s a concept called the Stockdale Paradox named after an American military leader who was the ranking officer at the Hanoi Hilton during the Vietnam War. It was clear that when he and the surviving soldiers were released that most prisoners of war had died in captivity. Asked what best characterized those who perished, Stockdale said: “That’s easy — it was the optimists.”
Those who set aspirational expectations for gaining freedom ended up dying of a broken heart due to their lost resolve. It was only those who abandoned all hope who made it home.
Q: When my investment club friends meet and we start talking about our individual investing techniques, I find a lot of their strategies seem to be biased. How can I explain to them in a simple and clear way about behavioural and unconscious biases? I know we all have them, but I think it would help our investment returns if we all better understood what they were. — Randy
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Article content FP Answers: There’s a broad consensus that we all have biases. Even Daniel Kahneman, the esteemed psychologist, professor and bestselling author who may be the world’s foremost authority on the subject, acknowledges he is biased. If Kahneman is biased, it seems likely that you, me, members of your investing club and everyone else is biased, too.
The first step in solving any problem is acknowledging that you have biases in the first place. Since there are literally dozens of behavioural biases out there, it would help to pick up a book on the subject that offers some counsel. All those books on investing behaviours, as well as my own book, Bullshift, deal with many of the most prominent behavioural biases we face, especially risks associated with overconfidence and optimism.
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Article content The challenge with biases is that people either resist acknowledging they have them or fail to properly recognize them. Research shows we are better at identifying bias in others than we are in ourselves. Perhaps your investing club could discuss bias at a future meeting. Be forewarned, however, that certain biases such as confirmation bias (looking for information that supports your pre-existing viewpoints), groupthink and herding are all biases that might be part of the problem.
Should we use TFSA savings to pay off our mortgage? Borrowing money to invest: The pros and cons Single mom pays off her mortgage, wants help with her RRSP and TFSA People in a group setting tend to coalesce around whatever the first speaker says about a subject. Guard against this by giving members some homework. Have them write down what biases they believe they and others in the group are prone to.
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If the ideas are in writing and itemized separately before everyone meets, they are more likely to represent true viewpoints and gain traction with your members. Failure to do so can cause people to simply go along with their peers, which is an inadvertent form of peer pressure.
John De Goey is a senior investment adviser and portfolio manager with Wellington-Altus Private Wealth, a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
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