Concealed Emotions

Two forces control every investment market: 1) money is emotional, 2) most people don’t think they’re emotional.

But it’s not denial. Most of us just have a bad sense of what emotions look like.

The picture of the emotional investor you may have in your head is the poor sap literally crying over losses. Or the maniac taking out a second mortgage to bet on a penny stock. As long as you can say, “That’s not me,” you can tell yourself you’re an unemotional investor.

And you’re probably wrong.

An emotion is just the gap between what you think could happen and what could possibly happen. Which is a whole lot of stuff. And it comes in a whole lot of forms, some of which aren’t obvious.

Forecasting is an emotion because it relies on things staying the same, which people often want because it supports their existing views, or things changing, which people often want because it supports their existing views. You forecast either because you want to know the future, or you want other people to think you know the future. And it’s nearly impossible to divorce the potential glory and loss from that when making uncertain assumptions. A truly unemotional person is hesitant to forecast to begin with.

Confidence is an emotion because it relies on an assumption that whatever skills you have today will be adequate and relevant in the future. The most powerful skills – ones that create outlier success – tend to be niche. And niche skills have two attributes: Since they’re rare, they make you confident, because being good at something few others can do gives the impression that you’re immune to competition. But since they’re niche, they’re the most susceptible to change and extinction. Grinding patiently in a library was an investment skill until all annual reports were digitized. Then being a spreadsheet master was a skill, until every investment banker used the same models. Men likely got an inflated sense of their work worth during the thousands of years when muscles determined productivity, vs. the current world where things like communication and empathy play a bigger role.

Any degree of optimism or pessimism is an emotion because it relies on assuming you know how people will behave. Which, historically, is one hell of a flier. Most of the field of history is devoted to telling stories about groups of people who didn’t behave as expected. You can say the odds of optimism or pessimism are in your favor, and you may be right. But how people size up odds is often tied to their preconceived view of a topic, which itself is an emotion. And most probabilities are less than 100, so even when you make a good bet you’ll occasionally end up on the wrong side. That requires dealing with loss in the face of making a good decision, which so few people have mastered – the natural reaction is giving up or changing your position even when you made a good decision that ended in a bad outcome.

Goals are emotional because you’re anticipating a future where things are better than today, or avoiding a situation where they could be worse than today. The point of a goal is managing regret, and regret is an emotion. So any time you save for retirement, or your kids’ education, or imagine a world where you’re out of debt, you’re diving into a world filled with overconfidence in how you’ll feel when a goal is met, or potential disappointment when they aren’t.

Ambition is an emotion for the same reason author Tali Sharot says optimism is a rational form of ignorance:

It protects us from accurately perceiving the pain and difficulties the future undoubtedly holds, and it may defend us from viewing our options in life as somewhat limited. As a result, stress and anxiety are reduced, physical and mental health are improved, and the motivation to act and be productive is enhanced. In order to progress, we need to be able to imagine alternative realities — not just any old realities, but better ones, and we need to believe them to be possible.

Comparison is an emotion because when you measure your wealth or returns against other people you likely discount the effect luck has on results, since luck is hard to measure and rude to imply when analyzing others.

None of these are the picture of an emotional wreck. They’re the day-to-day norm of good investing. But it’s all emotional. It’s why Munger says, “How could economics not be behavioral? If it isn’t behavioral, what the hell is it?”

James Grant put it differently: “To suppose that the value of a stock is determined purely by a corporation’s earnings is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed.”


The Psychology of Money

Casualties of Your Own Success

Rules in the Textbooks, Guidelines in the Trenches