Perception, Fear, and the Art of Not Panicking

Photo by Thanos Pal on Unsplash

Human perception is a funny thing. For example, I always assumed that if a person were born without eyes, they would still see the same color of black that I experience when I close my eyes or walk into a room with no light.

But that isn’t what happens. Instead, a person born without sight sees nothing. I heard it analogized as what a sighted person experiences when objects fall outside their peripheral vision. It isn’t that those areas appear black. They simply do not appear at all.

Similarly confusing, I recently read this article in Scientific American describing how doctors used a precise laser setup to stimulate the retinas of five participants, making them the first humans to see a color beyond our visual range.

I can’t even begin to imagine a color I’ve never seen, but such are the limitations of being human.

So, What Does This Have to Do with Investing?

Successful investing begins with acknowledging the limits of our perception and developing systems that compensate for our cognitive blind spots.

For example, I’ve spoken with several investors who wanted to sell all their stocks and bonds so they could move to cash.

What they said was, “I just can’t lose any more money. This administration will collapse the stock and bond markets, and I can’t afford to take those losses.”

What they meant was, “I’m scared of the current administration, but I can’t do anything to stop it. I need to feel like I’m doing something to protect myself, and moving to cash is the only strategy that will eliminate the risk of further short-term losses. Since I can’t take any other risks off the table, eliminating that one will make me feel better.”

This sentiment is common, but it is also just a manifestation of our lizard brain’s Zero-Risk Bias.

Zero-risk bias is a cognitive bias where people prioritize eliminating a specific, seemingly minor risk, even if it means accepting a larger overall risk elsewhere.

During the pandemic, for example, people couldn’t eliminate the risk of getting COVID, but they could eliminate the risk of running out of toilet paper. Even if it meant creating serious supply chain issues or increasing the risk of getting COVID by waiting in crowded lines, people hoarded toilet paper, and it made them feel better.

This is how our brains operate. They want us to feel better, even if that means solving the wrong problem.

Consider investors in retirement. Their most significant risk is running out of money. But retirement is long, the future is uncertain, and running out of money is a risk that can’t be eliminated with complete certainty. So, instead, when things get scary, humans move to cash.

It is a generally terrible decision that has historically made them more likely to run out of money in the long term (see chart below), but in the moment, that doesn’t matter. The only thing that matters is that moving to cash eliminates the risk of seeing the account go down in the short term, and that certainty makes them feel better.

This is why having a plan is so important. It isn’t about evaluating which stock to buy or which macro strategist to follow. It is about creating a game plan for overriding our worst instincts in times of crisis and having the humility to recognize that our financial perception, like all human perception, captures only a fraction of reality.

That urge to sell everything is human. The ability to ignore that feeling is divine.

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Personal Note:

This morning, I'm presenting at my 4th grader’s career fair. I'll discuss the power of compounding, the importance of spending less than you make, and all things financial planning.

And when everyone stops paying attention, I’ll hand out tens of billions of dollars in Zimbabwe currency.

This is my third year presenting. If history is any indicator, the kids who leave the classroom most excited are the ones who least understood the point I was trying to make about inflation.