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الاثنين، 27 نوفمبر 2017

Terror Attacks, Rationality, and Investing

I got off work early on Oct. 31st, hopped on my bike, and started pedaling down 2nd Avenue in New York. I was feeling the wind on my face as I went over the Manhattan Bridge and into Brooklyn when I heard my phone ring. I ignored it and continued to enjoy the ride and the nice weather. Then it rang again, and soon after, a third time. I figured so many calls in quick succession meant something was up, so I pulled over and checked my phone.

All the calls were from my wife, and I had a worried text from her as well. I immediately called back, fearing she was in trouble. When she picked up the phone sounding scared out of her mind, I was sure something horrible had happened. Thankfully, she was okay. Tragically, eight bicyclists on the other side of town were not.

She was trying to reach me because she had just learned some horrific news: Eight people biking along the West Side Highway bike path were killed by a terrorist who drove a truck onto the path. It was an awful, heartbreaking incident.

My mother immediately called to make sure I was okay. Her relief, though, quickly turned to frustration and confusion when I told her that I’d still be biking to and from work the next day, the same as always. She tried to say it was now especially unsafe to bike, while I argued it would probably be even safer than before, since it was such a big story and drivers were sure to be on high alert.

I also argued that the goal of terror attacks is to instill fear. I wanted to continue biking as a way of making my own little statement. It was important to me that I stay rational. The frenzied news media, a worried mother, and an evil person hoping to strike fear into my heart would not be enough to disrupt my routine.

As I biked to work the next day, I felt proud that I stayed rational in the face of fear. I also realized the same thinking that got me on my bike that morning has also helped me get out of debt, build my emergency fund, and start to wisely invest my money. There is a deep connection between staying rational and keeping your financial life in order.

Staying the Course

I have made it part of my overall life plan to ride my bike when the weather permits. I’ve chosen to not let outside events have undue influence on this decision.

I’ve had scary falls while riding my bike, such as the time my tire got stuck in some train tracks when I was in San Francisco. But after falling, I didn’t sit on the ground, wail, wonder why the universe was punishing me, and make plans to sell my now completely untrustworthy bike. I got back up and kept riding.

Similarly, no matter what kind of investment strategy you use, you’re going to have some down years. Some of those periods will be really scary, such as the bursting of the dot-com bubble or the Great Recession of the late 2000s.

When the market went downhill in 2008, the media seized on the narrative that the sky was falling. Anyone who watched or read the financial press would have felt like there was no doubt we were headed for a dreaded “Japan Scenario,” which refers to the fact that Japan’s stock market crashed and then stayed down for a very, very long time.

I fully admit that 2008 was a scary time. The recession was severe, and it was on the verge of being even worse if certain governmental measures didn’t work as well as they did. But, eventually, we came back from the brink. The stock market regained its footing and then some. Anyone who hung on and didn’t sell has been handsomely rewarded in what is now the second-longest bull market in U.S. history.

The worst thing you can do is panic sell when you see your investments starting to go south. Far too many people did this back in 2008, only to lock in their losses and miss out on the roaring comeback of stocks over the following years. When investing, especially in stocks, you’ve got to have a long-term outlook.

Another reason a short-term outlook can hurt is the fact that every time you buy and sell a financial instrument, you have to pay a trading fee. The more active you are as a trader, the more those fees will eat into your returns, hence the common refrain “trading is hazardous to your wealth.”

The fees can get so bad that we’ve created rules to protect people from predatory financial advisors, such as those who use “churning” to rack up big commissions: buying and selling high amounts of stocks and bonds in a short period for no reason other than to rack up high fees. (This is one of many reasons to be careful choosing a financial advisor.)

If you try to actively trade your way out of a bad situation, you’re likely only going to make it worse. You can think of those transaction costs as driving up the overall expense ratio of your portfolio. Seemingly small differences in fees can affect your overall returns over a 40-year investing horizon by hundreds of thousands of dollars.

If you can hold tight when times get turbulent, you’ll keep your fees down and ensure you don’t sell at the bottom of a market crash.

Everything Comes With Risk

Every decision can be looked at on a spectrum of risk and return. When riding my bike, I accept the fact that I have an elevated chance of injury when compared with taking public transit. (I wouldn’t be driving a car, so the debate of cycling vs. driving safety can be left for another time.)

But, the way I look at it, the higher risk comes with higher rewards. I get to pocket the money I’d be spending on a gym membership in part because I get a 1.5-hour workout in every day as part of my commute. I get an extra 1.5-hours of natural light and fresh air, as opposed to being in the dank, dark, crowded underground caverns of the subway. And no sleepy, sniveling child has ever accidentally sneezed right into my face while biking. I could go on and on.

This is comparable to how I look at my investments. I invest in a diverse mix of volatile, uncorrelated assets that, in the long term, tend to have a high growth rate. In theory, it would be less risky to put everything I have into cash and CDs. Then I would never lose money in a stock market crash. Unfortunately, I’d also miss out on the magic of compounding interest. No risk, no reward.

Everyone has different financial goals, of course. If you’re a completely risk-averse retiree who is saving up to purchase a boat in the next two years, then sure, put it all in cash. But if you’re younger and still trying to grow your nest egg, being too risk averse has its downsides.

Irrationality Is Everywhere

Why do homes sell for less money if someone previously died inside the house?

Fear.

Why don’t people want to live near power lines, despite the fact that the electromagnetic fields they emit have never been proven to be dangerous?

Fear.

Why does my wife want to throw out food that looks and smells perfectly fine just because the expiration date has passed?

Fear.

You can capitalize on this irrationality by making decisions based on data instead of fears and emotions. For instance, if you’ve run the numbers, and you love everything about a house besides its proximity to power lines, you should probably go ahead and get the house.

You Should Still Be Cautious

When biking, I wear a helmet, use front and back lights, obey traffic laws, go slower during bad weather, use turn signals, and ride with the flow of traffic. I see many brave souls weaving through traffic, wearing headphones but not a helmet, and blowing through red lights like they are a two-wheeled ambulance.

These folks will usually arrive at their destination faster than me, but their risk is elevated. Again, it’s a lot like investing.

You can get rich by riding the wave of a leveraged asset bubble and getting out at just the right time. I personally know a few people who are trying to do that via investments in cryptocurrencies like Bitcoin.

The problem is, it’s hard to know when to get out. If you grow accustomed to 60% monthly returns, or riding 30 city blocks in five minutes, it becomes your new normal, and you don’t want to stop. The wake-up call will come in the form of a crash, whether financial or on the road.

I much prefer to follow the timeless wisdom from Aesop’s “Tortoise and the Hare” — slow and steady wins the race.

Summing Up

If every cyclist let this one tragic event prevent them from biking, it would have devastating ripple effects. A bigger burden on transit systems and already congested streets, more pollution from burning fossil fuels to get around, and a sense that terrorists are winning by making us live our lives in fear.

All those negative behaviors have analogues with investing. You will wreak havoc on your portfolio if fear and emotion cause you to overreact to risks, make you prone to panic trading, or become too short-sighted to stay the course.

I got a little emotional when I got on my bike the morning after the attack and saw a healthy amount of commuters cycling right alongside me. I felt that we were all making a statement, together. The notoriously ornery New York City crossing guards and traffic workers were even being nice. At one heavy intersection, a crossing guard yelled at the motorists in a thick, unmistakable New York accent to “Let the dang bikah’s cross!” while waving at the cyclists and smiling. Say what you will about the negatives of living in NYC, but the people’s desire to watch out for each other and to stand strong in the face of adversity makes me proud to be a resident.

If we can all work to overcome our irrational fears, we can not only live healthier lives, but we can also do a better job of growing our wealth.

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