Property market commentary has become infused with a tsunami of theories as to why the world is ending.
Some represent credible threats, of course.
Others represent no such hazard, yet have been espoused so frequently they are increasingly being treated as common knowledge.
When “everyone knows” something it’s often a good time to consider whether “everyone” might just be wrong.
I’m going to look at a number of common myths in the next few weeks, and today it’s…
“I knew this would happen!”
Plenty of internet bandwidth is taken up with “as I expected…” type property market commentary.
It’s worth considering for a moment who the authors are trying to kid – is it themselves or their readership?
Just as likely, it’s driven by hindsight bias.
Hindsight bias is a cognitive trick that our brains play on us after events have played out, which can subtly turn a passing thought of what might happen into a belief that we somehow actually knew what would happen (often followed by a rapid-fire round of boasting!).
Trouble is, we conveniently tend to forget the countless thoughts we had which proved to be completely wrong!
When an investment underperforms, we often prefer to believe that we “knew” that it wouldn’t work out all along.
But rarely is this true.
If it was, then why did we ever follow the investment path we did?
The global financial crisis and ensuing stock market crash is an excellent case in point.
Everyone is an expert in the causes and the timing of the financial crisis today.
And they’ll write books about the next global recession after the event too!
The truth is, when it comes to money we rarely think as rationally as we think we do.
For example, studies in behavioural finance have shown that we tend to feel twice as bad about losses as we do good about gains.
Here’s a simple 30 second exercise:
Suppose I said you could select one ball, blind-folded, from Box 1.
If you pick a smiley face then I give you $100,000, but if by chance you should pick a sad face then you receive nothing.
Alternatively you can just whip out the ball from Box 2 and receive a guaranteed $75,000.
Which choice would you instinctively go for?
Yep, so would I!
Now instead say you could select one ball blind-folded from Box 1 and if you pick one of the three smiley faces you would lose $100,000, though if you pick the sad face then you lose nothing.
Alternatively, you can just pick the ball from Box 2 and lose a guaranteed $75,000.
What now? Box 1?
Aye, same for me.
The choice seems intuitive because on average when it comes to money we despise losing more than twice as much as we love winning.
Finally, what if the guaranteed win from Box 2 was instead a $75,000, and Box 1 represented a three-in-four chance of winning $125,000 (and a one-in-four chance of receiving nothing)?
Still going for the guaranteed $75,000?
A slightly more difficult choice now, but most would still take the guaranteed $75,000.
This is normal human psychology and known as loss aversion, or sometimes myopic loss aversion.
Essentially it’s a short-sightedness which urges us to look out for our immediate well-being, but sometimes at the expense of long term success.
Behavioural finance research shows that people are also often twice as thrifty in a recession as they are frivolous in boom times, for very similar reasons.
These are very similar to the instincts and emotions that arise when we make winning or losing trades in the share markets and explains in part why most share traders make little or no progress.
We are often unwilling to take losses for it is admitting that we got a trade wrong or made a mistake.
This is completely illogical, because all shares traders pick wrong trades, as it is impossible not to.
Winning share traders cut losing trades quickly and let the winners run.
Most people do the exact opposite by snatching at winning trades too quickly to ‘lock them in’ and allowing losing trades to slide in the hope that they ‘come back’ (“it’s a long term investment!”).
Instincts are often wrong
What’s the relevance of this?
The point is, our instincts are often wrong; our minds play tricks on us and we tend not to think rationally about money or investment.
In particular short terms losses we feel much more acutely than long term gains feel satisfying.
Why do we think this way?
It’s hard to say for certain, but my reckoning is that it’s derived from a primeval survival mechanism that humans have continued to develop over generations – we will always be acutely aware of short term risks to our well-being, while long term outcomes seem less pressing.
Further, we unconsciously link actions to the way the make us feel at that moment in time.
Long term success
This is one of the key reasons why so few people achieve financial freedom through sensible long term investing.
In property investment, the statistics show that the overwhelming majority of investors own just one or two properties, which is very rarely enough to achieve financial goals.
And despite what commentators would have you believe, mostly they are hopeless at forecasting the future.
It’s not actually their fault.
The number of variables involved in what makes markets move is beyond huge.
Impossible to forecast with any meaningful level of accuracy.
Perhaps your mind has played a trick on you and you have become wise after the event yourself at some time.
I think that’s happened to all of us at one point or another.
But I challenge you to go back five years ago and find anyone – I mean anyone at all – who forecast what would happen to Australia’s property markets from 2011 until today with any meaningful level of accuracy.
Some have been much better than others, yes.
But none have been totally accurate.
And you can’t time corrections accurately either, even if your instinct tells you otherwise.
The logical approach is to invest with long term probabilities in mind, because consistently calling short term turning points with any level of accuracy can’t be done.