Peck Bulgin Wealth Management

Our Commentary

Why Does Pessimism Sound So Smart?

Written by Casey Bulgin, CFP®, AEP®
Vice President – Investments
Peck Bulgin Wealth Management of Raymond James

As we are all aware, the financial world has no shortage of analysis and opinions. With 24-hour news, we can turn on the television, open up a computer or phone at any hour and get someone giving us market insight. This overabundance of financial opinions clouding the markets every move reminded me about the perception between a pessimistic view and an optimistic view as it relates to investing

Someone brought this to my attention a few years ago and now I have noticed it more and more – pessimistic views are often viewed by individuals as smarter. Why is this? There is actually a very simple answer rooted deep in our psyche.

If you turn on your favorite news channel and start to pay attention to this, you will notice the pattern. There is an analyst on one side of the table talking about how the fundamentals of the market look surprisingly good, the jobs numbers are climbing and corporate profits seem to be increasing; then on the other side of the table there is someone telling us that the market is overbought, interest rates are a ticking time bomb and that the election is poised to ruin the markets. Ten times out of ten, the analysts with an optimistic view will be perceived as detached from reality while the pessimistic analyst will seem to sound smarter and more in touch with what's really going.

This perception could be due to the concept in cognitive psychology and decision theory known as Loss Aversion bias. This was developed and initially studied by Daniel Kahneman and Amos Tversky in 1979. This research was to show people generally feel a stronger impulse to avoid losses than to acquire gains of an equivalent amount. Simply put, psychologically, the possibility of loss is on average twice as powerful a motivator than as the possibility of making a gain of an equal amount.

So how does this relate to investments? This Loss Aversion bias leads almost directly into another bias, Status Quo bias. This is the tendency for people to be resistant to change. When we think about change, we focus heavier on what we might lose versus what we might gain.

This is the point where a bias like this can severely affect an investment portfolio. When investors are so resistant to change that they prefer to stick with an investment or strategy because they are more worried about what they might “lose” versus what they could “gain.” This is why our brain tends to view the pessimistic opinion more favorably because it satisfies the side of our brain that could be looking for that confirmation.

There is nothing wrong with weighting loss prevention over potential gains especially when it comes to things as important as your financial future. The real danger of this bias lies in expectations of investments – understanding that investments with lower risks will underperform in good times, despite this seeming obvious, is a step in the right direction. Without proper coaching many investors can succumb to these biases at the wrong time and lead them down a path of having to play catch up.

When we structure our client’s portfolios, we ensure they have identified investments that are earmarked for use much later in life and then a separate bucket of funds that will be needed sooner. These two buckets of investments should have clear expectations on the risk as well as the return during times of volatility.

Very often a client’s risk tolerance is not in line with the desired return and expectations laid out between advisor and client. Through increased communication and proper expectations regarding performance, you can overcome these biases. These imbalances are usually harder to see when times are good and tend to be on full display when times are tough.

During this time of increased market volatility due to the pandemic, I encourage you to speak to your advisor to ensure you have a balanced mix of funds that are to be used much later in life as well as those you may need access to sooner. I encourage you to remember that not all pessimistic views are right while not all optimistic views are right either. Through a well-defined strategy and expectations, an advisor can clearly develop a strategy that works to meet your needs as it relates to expectations and corresponding risk tolerance.

If you would like to learn more about how we manage this with our clients, reach out to us today. We are here to help get you through this challenging time.

This material is being provided for information purposes only. Investing involves risk regardless of the strategy selected. Past performance doesn't guarantee future results.