Patience is a Virtue
In case you missed it, we just survived three fiscal crises on three different continents and came out just fine.
Greece (we've been discussing for weeks) slid through its economic crisis on the backs of the European bankers again.
China, whose stock market (available only to the Chinese and not to us) slipped more than 25%, watched its government buy up shares to buoy returns.
Puerto Rico, it turns out, will not sink the United States with a default on its municipal debt.
Meanwhile, the stock market shrugs.
We all suffer from what the white coats call "myopic loss aversion." We look at what is happening today and we worry. We forecast that out into the future and say to ourselves, "the end is coming!" Perhaps none of the three crises I mentioned are among your top three worries. Is it any different?
Myopic: short-sighted. Loss: a temporary decline in stock market prices. Aversion: it hurts twice as much to lose money as feels good to gain the same amount.
Ask yourself the following question: Would you bet $100 for a 50% chance of making $200 and 50% chance of losing it all? The gain is twice the loss and the odds are even. What would you do?
A clever person once said, "I would not take a single bet, but I would take your bet 100 times. Over time, the odds are that I will have won 50% of the time and lost 50% of the time, so I will have made on average about $5,000. Here's the math on that: 50 x $200 is $10,000 gains less 50 x $100 is $5,000 losses, leaving me with $5,000 more than I had before."
Investing in the stock market is like that. The risks that surround us every day are omnipresent and feed upon our myopic loss aversion. We fear that today the coin toss of the market - a drop in stock prices - will continue. The more we look at the market and our portfolios, the more we may see declines, and the more fear we feel. These animal instincts kept us alive, ages ago, fighting for survival, but hurt us slowly over the duration of our investment lives.
Think about that bet. Do you feel the pain of a loss twice as bad as you feel a joy for a similarly size gain? If so, you're in good company!