Foolish Mindset 2016

7/25/2019 Foolish Mindset 2016

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Morgan Housel is a longtime Motley Fool columnist who focuses on big-picture

issues in the economy and how they affect investors lives.

With his Motley Fool Mindset series, Morgan brings you our best guidance on know-

ing yourself as an investor, making sense of the macro matters in the world around

us, and mastering the concepts that will put and keep you on the path to Foolishsuccess.

Heres a special report with several essential articles that will help you stay Foolish

during times when it looks like the market has lost its way.

In this report:

What Happens NextKeep calm by keeping perspective todays pain can lead to tomorrows gains.

Get Ready for the Next Bear MarketWhat you invest in wont matter unless youre willing to stayinvested.

Our Foolish Investing EdgeDont worry what others think in the short term wealth comes from a long-term focus.

Battle Your Brain: How to Become a Less-Biased InvestorSuccessful investing is less about what you know and more about how you act.

How to Keep a Foolish Mindset

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The MoTley Fool Janua ry 2

What Happens Next?Keep calm by keeping perspective history shows that todays pain can lead to tomorrows gains.

The stock market has increased almost -fold

over the past years. Thats an astounding rate

of growth captured in a timespan shorter than the

average life expectancy.

But heres whats amazing. During that period of

growth, stocks spent the vast majority of the time

well off their all-time highs.

Investor Michael Batnick put together this great

chart for me, showing the percentage of the time

the S&P has been down % from its all-time

high (gray), down % from the high (blue) anddown % from the high (red):

Crunch all the data, and youll see that the

market is at an all-time high just % of the time. In

fact, the market is:

0% to 5% belowits all-time high 36% of the time

5% to 10% belowits all-time high 15% of the time

this is where we are now

10% to 20%below the all-time high 22% of the time

20% or morebelow the high 21% of the time

The important takeaway is that short-term

market declines do not preclude big long-term

market returns.

Think about it: During a period when stocks rose

-fold, they were below their all-time high % of

the time.

If you want something better than average

in investing (or most things in life), you have to

be willing to pay a price. For stocks, that price is

enduring common-but-uncomfortable short-term

volatility. Since not everyone is willing to deal withthat uncertainty, there is opportunity for those who

are. And thats exactly why stocks do well over the

long run because we occasionally have months

like this.

This article was originally published in August 2015.

R , R R


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The MoTley Fool January 3

Get Ready for the Next Bear MarketWhat you invest in wont matter unless youre willing to stayinvested for the eventual recovery.

Heres what I think is the most important topic in

investing: How you behave during bear markets.

This one topic will likely have the most influence

on how you perform as an investor over the long run.

Why? Because you can be the best stock picker in

the world, capable of finding tomorrows winning

businesses before anyone else. But if you let your

emotions get to you and sell stocks when a bear

market arrives, none of it will matter. You will fail

at building long-term wealth.

Prepare Now to Make the Right Move

I looked at what happens in the five years after the

market drops by a lot. Historically, the more the

market has dropped, the higher the odds it will

rise over the next five years and the larger

those subsequent gains are likely to be.

After a % drop, stocks are higher five years

later % of the time. The average return during

that period is %, which is great. If the market falls

% from its all-time high, historically its been

higher five years later % of the time. And if the

market were to fall %, there has never been a time

in history when it wasnt higher five years later.

History is under no obligation to repeat itself,

of course. But successful investing is about being

present when the odds of success are in your favor.

And after bear markets, the odds of future success

rise substantially.

This is so important for investors to understand

because no matter how persuasive this data may be,the emotional urge during bear markets is to think

the opposite.

Losing money is painful. Your brain hates pain,

odds that the

S&P 500 is

higher in 5 years average subsequent 5-year return

47%80%

81%

82%

86%

89%

90%

94%

99%

100%

48%

51%

57%

61%

63%

78%

78%

102%

R

and so bear markets can cause an overwhelm urge

to sell stocks after theyve dropped. If you under-

stand the historical data, this is the least-rational

thing you could possibly do. But its what we see

from investors around the world every single time

stocks decline.

Were not into trying to predict when the next

bear market will come. Nobody can do that. But we

know it will come, and preparing yourself now for

the inevitable next decline is one of the most helpful

things any investor can do.

The pain of the past few weeks sets us up forhigher, and more probable, future returns. It could

easily get worse from here. But the worse it gets, the

higher the odds of future success.

Volatility scares enough people out of the market to

generate superior returns for those who stay in.

Wharton nance professor Jeremy Siegel


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Our Foolish Investing EdgeDont worry what others think in the short term wealth comes from a focus on the long term.

Last spring after one particularly red day in the

market, Chris Hill, host of The Motley Fools radio

show, received a heckling email:

But that was even true. In fact, Chipotle MexicanGrill(CMG) had fallen more than % that day.

Some investors look at this drop as proof that our

admiration and ownership of Chipotle a favorite

across many Foolish services and advisors was

proven wrong. Like we made a mistake. Egg on our

face. Shame on us.

We dont think about investing this way, and

understanding why were OK owning a stock that

drops % in a single day is paramount to understand-

ing why some investors have a terrible experience in

the market while others build long-term wealth.

Heres how I explained our faith in Chipotle and in investing

Foolishly in April 2015. The stocks returns have gone up

and down (and will surely do so again) since then.

Motley Fool Rule Breakersfirst recommended

Chipotle in January . The stock has since gone

up nearly %. Tom Gardners Everlasting Portfolio

recommended Chipotle in December and has

earned a % return. Those results are phenomenal.But Chipotle has been an utter roller coaster

since weve owned it.

I crunched some numbers to show what I mean:

Since January 2007, Chipotle has closed down 5%

or more 47 times.

The stock has been down at least 5% in 12% of all

one-week periods. Thats more than 1 in 10 weeks.

Its been down 10% or more in 1 out of 5 six-month

periods.

And its dropped at least 20% in 1 out of every 7

six-month periods.

The stock fell 73% in 2008. It recovered, only to fall

another 40% in 2012.

It recovered again, then dropped another 10% in 2014.

Through it all, Rule Breakersincreased its money

nearly tenfold.

What would have happened if we felt like we

made a mista ke every time the stock fell %? We

would have never not once enjoyed market-beating returns in any stock for more than a few

months at a time.

Every investor should understand their edge. If

you dont have an edge, how you can expect to beat

the market?

Invest Like a Fool

Let me tell you what I think our edge is: We dont

mind getting emails like the one Chris received. A lot

of investors share the views of the guy who sent the

email, but we dont. No one around here cares much

about what a stock did in any given day, or even

month. We care about long-term results. If were

truthful and honest at implementing this mindset,

we will stand apart from the crowd and not get

caught up in the emotional traps other investors do.

Thats our edge. Its simple, but its so powerful.

Are days and weeks like this fun? Not really. No

one enjoys watching their wealth decline. But we

know theyre going to happen. And we know thatwhat happens to one stock in any given day even

any given year is largely irrelevant to meeting

long-term goals.

Short-term thinking is one of the biggest dangers

in investing. Its a surefire path to ruining your

experience as an investor. If you can avoid it you

will do better than the vast majority of investors,

amateur or professional.

The Motley Fool owns shares of Chipotle Mexican Grill.


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Battle Your Brain: How to Becomea Less-Biased Investor

Successful investing is less about what you know and more about how you act.

Youve probably never heard of Mohnish Pabrai. And

theres a reason for that.

Pabrai is one of the most successful investors of

the past years. One dollar invested in his hedge

fund in would be worth more than today,

versus . in the S&P . And thats after my

ridiculous fees, as Pabrai jokes.

Why have you never heard of him?I first learned of Pabrai from a friend in .

There was almost nothing written about him at the

time. He wrote a book in , but no publisher was

interested, so he self-published a handful of copies.

I discovered that Pabrai lived near me, gave

him a call, and asked if I could interview him. He

graciously agreed.

I came to his office expecting to see a normal

hedge fund arra ngement: dozens of well-dressed

analysts, rows of Bloomberg terminals, TVs tuned

to CNBC.

But I found something completely different.

Pabrai manages more than half a billion dollars

entirely by himself. He became one of the worlds

best investors with a desk, a filing cabinet, and a nap

room. I have a hard time getting past the day with-

out the nap, so the nap is a must, he says.

Pabrai was the antithesis of most hedge fund

managers. This made me even more fascinated in

his success. So I asked him what his secret was.Control over my emotions, he said.

Thats it? I asked.

Its huge, he said. Its all you need. Youd be

surprised.

Pabrai isnt a successful investor because he has

more information than everyone else, or because

hes better at math than everyone else, or because

he knows more about business than everyone else.

Hes successful because he has won the battle with

his brain.

The reason you probably havent heard of Pabrai

is because he has such control over his emotions

that he has little desire for fame. I dont think he

feels the need to be on CNBC or have his face on the

pages of The Wall Street Journal. Hes emotionally

grounded enough to be content reading at his desk.

Control Yourself

Successful investing has little to do with what you

know and almost everything to do with how you

act. This report will attempt to be instructive. How,

exactly, do you overcome these flaws? How do you

become more like Pabrai?

A few years ago, I interviewed Daniel Kahneman,

a Princeton psychology who won the Nobel Prize in

economics. I asked him if humans can overcome

biases or if they are deeply ingrained flaws that

were stuck with whether Pabrai is a freak of

nature, essentially.

They can be partially overcome, yes, he said.

There are ways people can become better think-

ers.He elaborated on how this applies to investors:

I think it is very important not to encourage

people to do things that are likely to expose

them to regret. The potential for regret is

something that investors should know about

themselves.

How much am I going to suffer if this decision

of mine doesnt work out? How easily am I go-

ing to think, Oh, I made a mistake? How prone

am I to think that I made a mistake? Its a big

variable, and really worth discussing, I think,

with clients because part of the inability to

stay the course ... you have to inoculate yourself

against regret.

At its core, overcoming cognitive biases is about

inoculating yourself against regretful decisions.


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This is, of course, easier said than done. And tack-

ling this subject for every personality would be

impossible.I see three areas that consistently cause inves-

tors huge amounts of regret:

Where you get your information

Who you talk to about your investments

How you keep yourself accountable to your goals

Lets go through each one.

1. Where You Get Your Information

Twenty years ago, only a few media outlets domi-

nated the dissemination of financial information:

The Wall Street Journal, New York Times,an early

version of CNBC, and Louis Rukeyser.

Today, those outlets make up a minuscule

fraction of whats published (and Rukeyser is no

longer with us). Financial media has exploded, with

hundreds of outlets providing thousands of opinions

each day.

Though thats mostly a good development, it can

also be da ngerous if you dont know how to use it.

The truth is that, while news coverage has grown

exponentially in the last two decades, the amount

of news has not. Todays financial media offers

copious amounts of drivel, gossip, rumor, innuendo,

and nonsense. As author Nassim Taleb once wrote,

The calamity of the information age is that the tox-

icity of data increases much faster than its benefits.

To avoid bias, therefore, it is vital that you as an

investor know how to navigate this world.

Finding reasonable information is about morethan using reputable sources. Consider this quote

from a December front-page Wall Street

Journalarticle:

Igor Panarin posits, in brief, that mass immigra-

tion, economic decline, and moral degradation

will trigger a civil war next fall and the collapse

of the dollar. Around the end of June or

early July, he says, the U.S. will break into six

pieces with Alaska reverting to Russian

control. California will form the nucleus of what

he calls The Californian Republic, and will be

part of China or under Chinese influence. Texaswill be the heart of The Texas Republic, a clus-

ter of states that will go to Mexico or fall under

Mexican influence. Washington, D.C., and New

York will be part of an Atlantic America that

may join the European Union.

Keep in mind, the economy was falling apart in

December . And this was The Wall Street

Journal, Americas most prestigious financial news

source, so people took this seriously. You may have

yourself.After years of trudging through the financial

media, heres how I would dissect a story like this

today to ensure it doesnt bias my behavior.

(a) Who Is Igor Panarin?

A quick search would have shown that Panarin, a

Russian political scientist, has a history of making

outlandish predictions. He first presaged the same

six-part American disintegration in . In previous

years, he augured what he called the New British

Empire, the New Eurasia, the Eurasia Union, and

a new global currency none with any success.

This is vital to know, because you instantly

realize that this prediction tells you more about

Panarins personality than his objective analysis

of the economy. Predicting collapse is just what he

does. Its who he is.

If you get to know enough financial pundits,

youll find this is a recurring theme. People who are

currently bearish on stocks Peter Schiff, MarcFaber, John Hussman have by and la rge been

bearish for decades. Bulls like Jeremy Siegel have

been bullish for most of their careers as well. Its a

reflection of their personalities.

After you learn the background of pundits and

analysts, you are less likely to take them as seriously

as you did before. You will learn that most analyst

are athletes in a full-contact sport called punditry.

Realizing this helps prevent you from being biased

by their views.

Battle Your Brain: How to Become a Less-Biased Investor


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(b) If Panarin Is Right, What Should I Do About It?

Lets say America is about to break apart into sixpieces. Or lets say the analyst predicting a market

crash is right. What should you do about it?

For most long-term investors, the answer is

almost always nothing.

If you need to sell stocks next week to cover your

mortgage, knowing if the market is going to crash

next week is vital. If youre investing for the next

years, what the market does next week is irrelevant.

If you are a day trader or hold short-term options,

whether a stock beats quarterly earnings is really

important to you. If youre a long-term shareholder,it shouldnt be at all.

The worst trait of the financial media is its

inability to recognize that investors have different

time horizons, which makes it impossible to offer

blanket advice. Yet it does all day long. Very few

sources of information come with a warning that

says This advice is intended for a -year-old

investor with at least years to invest. Instead,

its given as The market is going to crash and you

should sell. The truth is that the person writing

this information has no idea who you are, what your

goals are, or how long you have to invest. Even if

their prediction turns out to be accurate, you should

not assume it is applicable to you and your goals.

Because it rarely is.

To prevent media from biasing your financial

decisions, my sincere advice is: Consume less

of it. It does not have to be more difficult than this.

In his book The Information Diet, Clay Johnson

writes:

Its not information overload, its information

overconsumption thats the problem. Informa-

tion overload means somehow managing the

intake of vast quantities of information in new

and more efficient ways. Information overcon-

sumption means we need to find new ways to be

selective about our intake. It is very difficult, for

example, to overconsume vegetables.

We also have to distinguish between information

and analysis. Company annual reports, economic

data, and conference call transcripts have infor-mation. Pundits and analysts provide analysis. In

my research, successful long-term investors favor

information over analysis by at least a -to-

margin. Most people are good thinkers, but are

gullible to being persuaded by pundits who are

trying to grab attention. If you go for the informa-

tion and ignore the pundits, you will have a better

time coming to smart, unbiased decisions.

Stock picks, board posts, and articles within

The Motley Fools community are a great resource

because they are the closest bet you have to readingmaterial that aligns with your goals, strategy, and

investment philosophies. They are as close as you

will get to vegetables.

Outside of the Fool, I would advise favoring

books over articles. There are lots of bad books and

lots of great articles. But books are more likely to

be thought out, thorough, fact-checked, and edited

than most articles. They are also more likely to

make you think, rather than act, which is exactly

what you want information to make you do.

2. Who You Talk to About Your Investments

New York Timescolumnist Carl Richards has a great

saying. A financial advisor, Richards says, is some-

one who puts a gap between you and stupid.

Even brilliant investors are tempted to fall for

biases and do dumb things with their money. An

advisors job is to look you in the eye, shake his head,

and walk you back from the ledge.

One of the leading causes of biased financialdecisions is confirmation bias. Its the tendency

for investors to seek out advice from people who

already agree with their views.

I attend a lot of financial conferences, many of

which are theme-based macro conferences, gold

conferences, dividend conferences, and so on.

What astounds me at these conferences is how

closed off they are to differing opinions. If you

attend a gold conference and say anything negative

about gold, you will be treated as an ignorant



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outsider and avoided. People think they attend

conferences to learn something new, but Ive

learned thats not really the case. They attend tohave their views confirmed by other people. It is

pure confirmation bias. And its dangerous.

Kathryn Schulz, author of the bookBeing Wrong:

Adventures in the Margin of Error, once explained:

The first thing we usually do when someone dis-

agrees with us is we just assume theyre ignorant.

They dont have access to the same information that

we do, and when we generously share that infor-

mation with them, theyre going to see the light and

come on over to our team. When that doesnt work,

then we move on to a second assumption, which isthat theyre idiots. They have all the right pieces of

the puzzle, and they are too moronic to put them

together correctly. And when that doesnt work, we

move on to a third assumption: they know the truth,

and they are deliberately distorting it for their own

malevolent purposes. So this is a catastrophe.

If you dont surround yourself with people who

disagree with your views, youll never realize that

you can be just as biased and wrong as every-

one else. And youll keep making the same mistakes.

Part of The Motley Fools investing ethos is a

culture of encouraged debate. We not only accept

dissent when making stock picks but encourage it.

Junior analysts can and do tell their bosses why

theyre wrong. This is how we fight confirmation

bias.

But theres something we cant do for you, our

members: prevent you from buying more stocks

when the market is bubbly and selling out when it

crashes.

One of Kahnemans pieces of advice to avoidbiases is to have an advisor who is in a different

emotional state than you are. This is how individual

investors can avoid confirmation bias.

You should have a trusted person in your life

a friend, a relative, a co-worker who you run

financial decisions by.

This person should know you well. They should

know your goals and your flaws. But they cant be

emotionally attached to your financial decisions.

Their goal is to provide a trusted, yet unbiased,

opinion of your decisions. They put a gap between

you and stupid.

For the past seven years, I have shared mypersonal financial plan with fellow Fool Matt

Koppenheffer. I trust Matt, but he thinks differently

than I do. Hes not nearly as emotional as I am in

some areas, sees risks that I dont, and offers a point

of view that I could never come up with on my own. It

is a perfect arrangement for avoiding biases, because

while I trust Matt, I dont agree with everything he

says and he doesnt always agree with me. That is

exactly what you want. Rather than confirm my

views, Matt makes me think and puts a gap between

me and stupid. Every investor should have someonelike this.

3. How You Keep Yourself Accountable to Your Goals

One of the most important lessons Ive learned

about investment biases is that people are terrible at

predicting their future emotions.

Every investor I know says theyll be greedy

when others are fearful. They never assume that

they themselves will be the fearful ones. But some-

one has to be, by definition.

No investor wants to think theyll panic and sell

if stocks fall %. Theyre more likely to say that a

% decline would be a buying opportunity. This is

the right attitude, but the reason there will be a %

crash is specifically because some investors choose

panic selling over opportunistic buying.

My experience is that most investors who say

theyll be greedy when others are fearful soon realize

that they are the others. It has to be this way:When

everyone thinks theyre a contrarian, at leasthalf will be wrong.

When investors are bad at predicting their

emotions, sticking to their financial goals becomes

difficult. I can say I plan on investing a month

each month for the next years. Or I can assume

that I wont sell when the next market crash comes.

But those goals rely on the assumption that I can

behave the way Id like to in the future. And thats a

dicey assumption to make.

I have found that the best way to get a realistic



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picture of my future emotions is to document my

past emotions. You can do this by keeping an invest-

ing journal.Every investor, no matter how active or passive,

should have an investing journal. It doesnt have

to be elaborate. Just document how youre feeling

when you make investment decisions.

If you keep a detailed journal of your feelings and

emotions when making investment decisions and

review it over time, I think you will notice that how

you expected to feel when the market falls, or surges,

is far different from how you actually feel.

This is easy for me, because Im an investment

writer. All of my thoughts and feelings are docu-mented on Fool.com.

Id like to think of myself as a contrarian investor. Id

like to think a market crash is a wonderful thing to

take advantage of. I want to be Mohnish Pabrai.

But when I look back at articles I wrote in

and , as the market was crashing, I have to

admit: I was more scared and pessimistic than I

thought. If Im honest, they show that I have a lowerrisk tolerance than I think I do.

And I never would have known this unless these

past feelings were in writing.

Admitting this is part of the reason I choose to

hold quite a bit of cash in my portfolio. I dont want

to pretend that I have a high risk tolerance that,

objectively, is probably a fantasy. Right now, with

the market near an all-time high, that would be

easy to do. To prevent bias, I want to look at my past

behavior and realize that its probably a good indica-

tion of what my future behavior will be.I would recommend every investor write down

their feelings. A few sentences a few times per

year. Keep this journal active for years, throughout

different market conditions, and be honest with

yourself about what you find. It could be the best

tool you have to avoid future regret.


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