Hello again, fellow Sloth Investors.
Here’s part two of my exploration into the domain of investor psychology.
One of the great things about being a ‘sloth investor’, that is, adhering to a less is more approach to investing, is that it allows me to spend time on the other aspects of life that I find rewarding.
I particularly enjoy reading in my leisure time and count modern history, biographies, and contemporary fiction by writers such as Ian McEwan, Julian Barnes, and the recently departed Paul Auster as some of my favourite go-to pieces of literature.
In 2024, my reading has taken somewhat of a different turn as I’ve been drawn towards books that feature the works of contemporary ‘plein air’ painters. For those unfamiliar with the term, ‘En plein air’ is a French expression meaning “in the open air”, and refers to the act of painting outdoors with the artist's subject in full view.
One fine example of this artistic form is the British painter Peter Brown. In addition to books by him, more recently I’ve purchased a book by Adebanji Alade, who is currently the president of the Royal Institute of Oil Painters in the UK. Alade is another talented plein air artist.
Whilst reading Alade’s recent book ‘Painting People and Places’, I was drawn to this passage. My reason for sharing it with you now is because of the parallels that can be drawn to the first cognitive bias that I will write about in this piece.
“You can brush a painting to death, so you must know when to stop. This is a big problem with amateur painters. There’s a tendency to want to make sure everything is ‘tidy’, with every stroke perfect…the point is to stop as soon as possible after you have laid in all the big shapes, and put in the major details. If you find yourself starting to circle around and fidgeting without knowing where to lay the next stroke, it’s time to stop.”
While reading this passage in Alade’s book, I couldn’t help but immediately think of the realm of investment.
It’s now over 150 years since TNT was invented by the German chemist Julius Wilbrand. However, in my view it is the danger of TMT (Too Much Tinkering) that represents one of the biggest hurdles that investors must overcome.
I’ll now explain more….
Action Bias
Quite simply, as sentient human beings, we are programmed to act, whether this is our own actions or employing others to act on our behalf. What makes the field of investing so unique is that, contrary to so many other aspects of our life, very often the best course of action is to do nothing.
A key feature of a sloth investor is that he/she adopts a do-nothing approach to investing. It sounds counter-intuitive, doesn’t it? Think again about the creature that I have chosen as my investing spirit animal.
As you know, it’s a sloth. Sloths are relatively inactive creatures. Likewise, a sloth investor is inherently motionless (most of the time). Here are some wise words from the oracle of Omaha, Warren Buffett. In his 2016 Berkshire Hathaway annual report, Buffett espouses the merits of doing nothing when he states1:
“For investors as a whole, returns decrease as motion increases.”
Hopefully, you’ve recognised the importance of ignoring stock market forecasts. Despite this though, you still feel, well, that you should do something. It’s natural to think this way; it’s part of your internal monologue.
If we feel unwell, most of us will choose to take medication and if the pain persists, we’ll visit a medical professional. Similarly, if our car begins to make a strange noise, we’re inclined to investigate ourselves or, if motor car maintenance is not your area of expertise, then it’s likely you’ll consult a mechanic. In most realms of life, it’s undoubtedly the case that taking action is the most sensible and rational approach.
Contrary to this, though, within the field of investing, a sloth investor recognises that inactivity > activity.
Despite the inevitable temptation to tune into the never-ending forecasts and speculation of the financial media, your job is to simply tune out and ignore this investment noise. As Warren Buffett has previously stated: “Wall Street makes its money on activity. You make your money on inactivity.”
A study2 by Fidelity Investments further underscores this point.
Fidelity undertook a study to determine which of their accounts had performed the best. The purpose of the study was to capture information concerning the qualities of their investors that contributed to the best performance. Fidelity’s findings were certainly fascinating.
Interestingly, Fidelity discovered that the investor accounts that had been completely forgotten about by their account holders ended up with the best performance. The accounts were not tinkered with or traded in and out of. The account holders simply forgot that they existed.
Similarly, sloth investors are programmed to do nothing! (99.99% of the time).
Ingroup Bias
Ingroup bias refers to the tendency for individuals to favourably treat members of their own group compared to other groups. How does this specific bias relate to investing? Let me explain with an example from my own life.
As a young man, my view of the stock market was framed by two leading influences: the media and my family. On those occasions when the stock market was mentioned on television or in newspapers, it was invariably because of volatility or a sharp decline. Unfortunately for me, as an eighteen-year-old, I was yet to learn about the media’s bias towards negativity.
In addition to this, coming from a family that never invested and that warned me off the (supposed) dangers of investing, my mind was quickly (although wrongly) made up. I was quick to decide that the stock market was definitely not for me. No one in my family had ever invested and so I falsely concluded that it couldn’t be the right course of action to take with my money. Little did I know how wrong I was.
A key reason then, which explains my premature, naive decision to never invest, was the influence of my family. Their negative view of the stock market affected my own view, meaning that I allowed ingroup bias to influence my perception of investing. Whether it relates to investing or not, I urge you to consider whether you have ever allowed the groups that you are a part of to act as an echo chamber, thereby potentially causing you to take the wrong course of action.
What do you do when you are confronted with a course of action or a perspective that conflicts with your pre-existing views? Do you possess the humility to critique your prior perspective or do you take a mental shortcut and simply refuse to consider whether there may be some validity to an alternative viewpoint or course of action?
In summary, a key reason why it took me so long even to consider investing is that I didn’t want to confront the pre-existing views that defined my view of the stock market. I thought it was too risky, not for everyday people like me, and something best left to professionals. I had yet to learn the rational approach to investing that ultimately shaped the formation of my very own five bedrock investing principles (Simplicity, Low Fees, Own the World, Time, Headstrong).
Sunk-cost Fallacy
Have you ever sat through a terrible movie at the cinema simply because you didn’t want to throw away the money that you had spent to purchase your seat? If you’ve ever engaged in behaviour like this, then you’ve subjected yourself to a cognitive bias known as sunk-cost fallacy.
This tendency refers to a pattern of behaviour in which someone continues investing their time/money in a venture simply because they have already committed significant resources towards it, even though, ironically, it may actually be causing that person a loss.
Within the realm of investing, a great example of sunk-cost fallacy would be someone that pays a high fee for an actively managed fund (not a good idea) and they continue to pay the high fees irrespective of that fund’s performance. Ultimately, the better alternative would be to radically change course and divert funds to a low-fee index tracker. However, due to the sunk-cost fallacy, some investors opt to persevere with an inferior course of action.
Recency Bias
Recency bias refers to the tendency to extrapolate the recent past indefinitely out into the future. Let’s take bear markets as an example.
To the unseasoned, uninitiated investor, attributing too much weight to the glut of headlines generated during a bear market can result in feelings of despair, with the future looking hopeless. An effective remedy that will help you to reduce the effect of this cognitive bias, is to adhere to a longer-term view of the stock market.
Moreover, instead of bemoaning the recent onset of depressed stock market prices, in converse fashion, a sloth investor, particularly one with a multi-decade time horizon, welcomes the opportunity to purchase stocks at a discount.
A 2018 report initiated by Betterment – the largest, independent online financial advisor in the USA – provides us with a rich illumination of the effects of recency bias on investors. The report, titled ‘Betterment Consumer Financial Perspectives Report: 10 Years After the Crash’, outlines the results of a survey that was conducted with 2,000 respondents, eighteen years and older, living in the United States.
Of these respondents, 1,602 were at least eighteen years old in 2008 – the time of the market crash. When asked how they felt the US stock market (the S&P 500) had performed since 2008, nearly half the people surveyed (48%) thought that the S&P 500 had not risen in the past ten years and 18% thought it had gone down. The fact that two-thirds of the survey’s respondents responded in this way is staggering. During the ten-year period from 2008 to 2018, the return of the S&P 500 was in excess of 300%.
So, how can we account for the disparity between people’s perceptions of the stock market and the reality? Undoubtedly, the media hysteria surrounding the market crash of 2008, with its bias towards pessimism and alarm, would have been a significant factor.
As a sloth investor, you need to understand the importance of adhering to a long-term investing mindset. Though not easy, you need to question whether you have the tendency to attach too much emphasis on what has recently occurred in the stock market. On the flip side to bear market concerns, if you’ve been investing during a long bull market, have you come to assume that this will continue forever? If you have, then it’s important to prepare yourself for the inevitability of a future bear market. Rather than extrapolating recent market behaviour into the future, it’s important to understand the cyclical nature of the stock market and to maintain a long-term investment plan, as this will help you form a natural defence against the danger of recency bias.
Be Humble - Accept Your Foibles!
In addition to the two cognitive biases in my previous investor psychology article, I’ve now expanded upon four more cognitive biases that may affect investors.
So, the six cognitive biases that I have been written about are:
Loss Aversion
Information Bias
Action Bias
Ingroup Bias
Sunk-cost Fallacy
Recency Bias
Understanding each of them will enable you to understand more about the potential pitfalls that may lay ahead of you as an investor – pitfalls that could drastically reduce your ability to grow your hard-earned savings. Daniel Crosby, author of The Behavioral Investor3, states:
“The brain and the body, marvels of evolution and design elsewhere, are poorly matched to the specific task of compounding wealth.”
So, rather than deny the possibility of you succumbing to the effects of the cognitive biases that have been discussed, it is important to acknowledge the likelihood of your inherent predisposition to some (if not all) of them.
Investor and author James P. O’Shaughnessy states in What Works On Wall Street4:
“The key to successful investing is to recognise that we are just as susceptible to crippling behavioural biases as the next person.”
A Tight Grip
At this point, it is worth reflecting on one of the characteristics of sloths. A sloth’s claws work opposite to human hands; their default position is a tight grip and they must use force to open them. A tight grip on one’s investments is needed by investors, particularly during times of turbulence.
Optimism
Sloth investors display a bias towards optimism. It’s a pre-requisite for successful investing. It will keep you invested over the long haul.
In episode eighteen of The Sloth Investor podcast, entitled ‘Smells Like Sloth Spirit’, Jason Prohaska (my co-host) and I discuss the importance of optimism to one’s success as an investor. We’ve often referenced our love of movies during the podcast series and we’re both fans of Jim Carrey. Indeed, one Jim Carrey movie that can teach investors a key lesson about investing is Dumb and Dumber (stick with me).
Dumb and Dumber features Jim Carrey and Jeff Daniels playing two bumbling, immature adults with a lack of common sense and little worldly experience. There’s a scene where Lloyd, Jim Carrey’s character, an incredibly unsophisticated man, has finally been able to track down a beautiful woman named Mary. He asks her if there is any way that the two of them could end up together as a romantic item. Exhibiting an admirable sense of tact, Mary initially lets him down gently with several evasive answers. Eventually, though, Lloyd insists upon a firm answer about his true chances.
Here’s the exchange:
Lloyd: What are my chances?
Mary: Not good.
Lloyd: You mean, not good, like one out of a hundred?
Mary: I’d say, more like one out of a million.
Lloyd: So you’re telling me there’s a chance!
Isn’t this exchange great? Okay, so, at this stage, you could be forgiven for wondering what the connection to investing is. Well, something that struck me when I first watched this scene (and that may have struck you, too) is Lloyd’s sense of optimism. Despite the numerical odds being overwhelmingly against him, Lloyd determines that there may be a chance at love after all. Okay, so it may not be much of a chance, but certainly enough of a chance in Lloyd’s own mind to be a notable cause for celebration.
‘One out of a million’ truly are five words that should be enough to crush a man’s soul, but not Lloyd. His enduring sense of optimism will enable him to continue to pursue the woman of his dreams (despite the overwhelming numerical odds against him).
Let me be explicit now about the connection to investing. I think we can agree that Lloyd’s sense of optimism seems entirely irrational. However, Lloyd remains resolute and positive in the face of seemingly insurmountable numerical odds. My appeal to the readers of this article is to instil your approach to investing with an impenetrable sense of optimism. After all, if we heed the lessons of time, the fourth bedrock principle of a sloth investor, we can see that by remaining optimistic and honouring the principle of time (i.e. patience), the results of investing with a long-term mindset can be truly remarkable.
Here’s a recent post from Morgan Housel on ‘X’ (formerly Twitter) that echoes this sentiment:
Okay, so that brings to a close part two of ‘Mirror, Mirror on the Wall’, an exploration into investor psychology. If this article or it’s twin (part 1) provided you with value then please feel free to share it with other current (or potential) sloth investors that you know.
As an added bonus for my loyal subscribers, here’s that exchange between Lloyd and Mary that I referenced earlier.
So long for now!
The Sloth Investor