When I was much younger and new to working in the capital markets, an excellent mentor taught me a market maxim that has served me well. More money has been lost because of four words than at the point of a gun. Those four words are “This time is different.” We are all too ready to view our situation as unique.
I vividly recall a CNBC interview in late 1999 with a geriatric money manager who claimed that in the then current environment, a portfolio with a 100 percent equity allocation was safer for retirees than more traditional investing choices because market inflows from 401(k) contributions and the like provided constant market support. Accordingly, in his view, it was almost impossible for the equity markets to take a major hit.
We all remember how that turned out.
In their great book, This Time is Different, Carmen Reinhart and Kenneth Rogoff examine financial crises throughout history. They document how whenever such crises arise, alleged experts claim that “this time is different” — that the new situation has little in common with past disasters.
Reinhart and Rogoff call this problem the “this-time-is-different syndrome.” According to their analysis, “It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many booms that preceded catastrophic collapses in the past (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes.”
We live in an overconfident, Lake Wobegon world (“where all the women are strong, all the men are good-looking and all the children are above average”). We are only correct about 80 percent of the time when we are “99 percent sure.” Despite the experiences of anyone who has gone to college, fully 94 percent of college professors believe they have above-average teaching skills. Since 80 percent of drivers say that their driving skills are above average, I guess none of them drive on the freeway when I do. While 70 percent of high school students claim to have above-average leadership skills, only 2 percent say they are below average, no doubt taught by above-average math teachers.
In a truly terrifying survey result, 92 percent students said they were of good character and 79 percent said that their character was better than most people even though 27 percent of those same students admitted stealing from a store within the prior year and 60 percent said they had cheated on an exam. Venture capitalists are wildly overconfident in their estimations of how likely their potential ventures are to succeed. In a finding that pretty well sums things up, 85-90 percent of people think that the future will be more pleasant and less painful for them than for the average person.
Our overconfident tendencies are well-known of course and obvious in others if not to ourselves. The odds of playing college sports are long and the chances of an athlete reaching the pros are vanishingly small, yet every weekend astounding numbers of parents can be heard at their kids’ games talking about little Sally or Sam inevitably winning an athletic scholarship. Marketers take advantage of these tendencies too (which explains the success of credit-card teaser rates, for example). Our biases constantly impact our decision-making, obviously. As Daniel Kahneman and Dan Lovallo put it in a 1993 paper, “decision makers are excessively prone to treat problems as unique, neglecting both the statistics of the past and the multiple opportunities of the future.”
On the other hand, we are also highly loss-averse. This aversion is another well-known cognitive bias. Empirical estimates find that losses are felt between two and two-and-a-half times as strongly as gains. Thus the disutility of losing $100 is at least twice the utility of gaining $100. Loss aversion favors inaction over action and the status quo over any alternatives.