Evolution made us this way
90% of people who invest in stocks lose money. Yet if you read and watch videos about investing online, it seems easy to win at it. How can it appear easy to win yet almost everyone loses?
I want to talk about failure in investing. The overwhelming majority of us fail. Understanding the causes of this failure is necessary to prevent it.
Invert, always invert: Turn a situation or problem upside down. Look at it backward. What happens if all our plans go wrong? Where don’t we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead — through sloth, envy, resentment, self-pity, entitlement, all the mental habits of self-defeat. Avoid these qualities and you will succeed. Tell me where I’m going to die, that is, so I don’t go there. — Charlie Munger
I will share a personal experience where I lost at investing. Starting from this example, we will identify the human anthropological algorithms because of which we are uncertain awful investors.
Losing at crypto before it was cool
Years ago, I bought a little Ethereum. This was before it became mainstream. Overall I doubled my money, but it was in fact a loss because I should have multiplied my money at least twenty-fold.
At that time crypto was something really new. I bought a little Ether because I believed in the promise of the technology to have dramatic impact in the world. The investment was a about a monthly salary for me, so not that much.
My plan was clear. I would keep it for at least 5 years. Let it sit and check the price only after these years had passed. I realized there was a lot of volatility that would motivate me to sell at the wrong time. So I decided not to know what happens with Ethereum price.
After about a year, Ethereum has a big bull run. Big enough that news start reporting on it. Accidentally I stumble upon this information. I cannot help myself and check the price. It’s a big increase. I get excited and start following it.
As it’s often the case, a bull ran that’s on the news is coming to an end. Ethereum price starts dropping. I watch my profit decrease. There are upturns that give hope, only to be shattered by the subsequent drops.
After two months of this, I cave in and sell. Afterwards the price drops further for a some time. Only to then bounce back and rise to more than twenty-fold from the moment of my initial investment.
I was an uncertain awful investor. I got lucky to make a profit. But I lost big time overall.
This is a mild story. I don’t even count in the 90% who lose money. But it was all luck. My actual behaviour was stupid.
The three anthropological human algorithms why we are uncertain awful investors
1. There is no future
When we invest, if we are wise, we make a plan.
My plan to keep Ethereum for at least 5 years was quite good. Yet it failed because I had not considered my human nature. I had not anticipated how news of the price evolution would affect me.
Our plans fail because we don’t account for our own nature and we cannot really estimate the future beyond tomorrow.
Your unconscious (which I call the Paleo Robot) does not understand the future. It evolved to maximize survival and reproduction in the moment, over at most a day. The future beyond tomorrow was irrelevant for 99% of human history. Long-term causes of death were so insignificant compared to immediate risks that we evolved to be unable to consider them.
When we make plans for more than a few days, these are frail, weakly things. Our plans are abstract oversimplifications that don’t really take into account either what we will do or how the world will change.
We buy stocks when they are rising and unconsciously presume this state will continue. The drop in price is always a surprise for which we were unprepared.
We plan assuming we are emotionless robots. We are always surprised by our own reactions when ‘the sh*t hits the fan’ as they say. Iplanned to hodl Ether no matter what. This plan was doomed because I could not account for how powerful a bear run would motivate me.
2. Avoid pain, seek pleasure
When our assets go up, we feel pleasure. When they go down, we feel emotional pain. This is the core experience of investing.
Pain and pleasure are not random. They evolved as signals for survival fitness. Things that bring pleasure have been beneficial and the humans who pursued them survived. Things that bring pain have neem dangerous and humans who avoided them survived. Pain signals danger. We avoid future pain as a way to avoid risk.
For most of human history, risk was deadly. Most mistakes could kill you. Break a leg -> death. Fail at hunting often enough -> death. Fail to notice a predator -> death. Offend the wrong person in the tribe -> death.
This shaped us to be risk averse. Excessively so for the modern world.
When my Ether went down, this risk aversion kicked in. I fought it, but it overpowered me and I sold.
It’s not weak will to sell when you get scared. It’s human nature. Nobody can fight it through willpower.
3. Learn from others
The last nail in the coffin is our learning mechanism. We learn in two ways: from personal experience and from other people.
Investing is about learning from other people. When everyone buys a stock or crypto, your Paleo Robot want to buy it.
This imitation approach made sense for all of human history until very recently. If everyone in the tribe avoided eating a certain berry, it was advantageous for you to avoid it as well. This remains true even if nobody knows why they are avoiding that berry.
For investing this social imitation algorithm pushes us to buy when a stock is high and sell when it is low. This is the opposite of the advice to buy low and sell high. Which explain why so few people follow this advice.
When Ethereum started decreasing, I felt compelled to sell because I knew many people were selling. If I had believed the decrease was due to random change, the urge to sell would have been smaller.
We are uncertain awful investors
We make unrealistic plans that we break to sell when assets are at the bottom and buy when they are at the peak. Our imitation algorithm pushes us into a herd mentality where we copy each others’ mistakes.
At the same time the stock and crypto markets are hypercomplex popularity contests. If we were tabula rasa robots with no evolutionary algorithms, we would still find investing well incredibly hard. With our Paleo Robot running the show, it’s impossible.
Can you become a better investor?
Yes, by learning from successful investors how they compensate for their Paleo Robot algorithms.
I don’t claim to have the recipe for success. I am not Warren Buffett. I can only give advice based on a good understanding of these root algorithms driving the most common investing mistakes.
The first instinct is to assume you can overcome these algorithms by sheer will. Everyone believes this. Nobody does it as an amateur investor. Unless you have a decade plus of investing tens of millions of dollars, your Paleo Robot will panic at the worst times.
Make one decision then block information
This applies to going long. You decide at the beginning how long you will keep that asset. Let’s say 5 years. Then you block all information about it for this period and set an alarm to evaluate it in 5 years time. If possible, you should make it really hard to buy or sell it in this period (e.g. give the password to your account to someone else).
Cultivate a contrarian attitude
Michael Barry is a good example of this. The movie ‘The Big Short’ shows how much of a contrarian he is. He comes across as weird with his insistence to work barefoot and den-like office. He has cultivated a lifestyle and personality that rejected conformism. This has taught his Paleo Robot that imitation is not beneficial. This allowed him to discover the flaw in what everyone else was doing. More importantly it allowed him to bet a lot of money that he was right and everyone else was wrong. Regardless of intelligence and financial skills, without that contrarian mindset, I believe he would not have been able to assume this risk.
Warren Buffett shows a contrarian approach as well. He says he based his investing on deep research of fundamentals and understanding of companies and industries. He does not follow news on companies or watch endless YouTube videos with financial advice. I believe he intentionally isolates himself from other investors’ opinions so that his decision are not biased by social learning.
Use technology to compensate
On one hand you can use tech to limit loss anxiety. Put stop limits from the start.
On the other hand, you can use tech to balance your Paleo Robot impulses. When you are sure of an opinion about an asset, search for opposite views. If everyone is talking about an asset, that’s a red flag. Bitcoin price fell this year right after it has reached peak news and buzz.
There are also automated tools to advise your investment decisions. These are unbiased by the Paleo Robot. Ray Dalio’s company Bridgewater is the biggest hedge fund in the world. They use advanced algorithms, statistical processes and Artificial Intelligence in their investment decisions. Ray Dalio talks a lot about the dangers of being certain you are right when you are not.
At the end of the day, the best rule in investing comes from poker.
Don’t come to the casino with money that you cannot afford to lose. I would add that your human nature conspires for you to lose.
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