Fix It Friday Ep. 11 - Overcoming the Wacky Economics of Investor Behavior

• Loss aversion bias can lead to panic selling during downturns, mistaking temporary declines for permanent losses.
• Viewing stock purchases as buying parts of companies, rather than abstract financial instruments, can lead to better investment decisions.
• Investor Behavior: Investors often act irrationally, buying more as prices rise and selling as they fall, contrary to rational economic behavior.
• Avoid market-driven optimism/pessimism bias by focusing on long-term goals rather than short-term market movements.
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A copy of Fusion's current written disclosure brochure discussing our advisory [00:00:15] services and fees is available upon request or at www.fusionfamilywealth.com. 

Jonathan Blau: Hello everybody and welcome to another episode of. The Fix It Friday, uh, version of the Crazy Wealthy Podcast. Thanks for joining us today. Uh, today I thought I would [00:00:30] talk about what I call the, uh, UN understanding and overcoming the wacky economics of investor behavior.

1. I call it wacky economics because, uh, the, the way investors behave as it relates to [00:00:45] processing financial and economic inputs that relate to stock prices and buying and selling and so forth, is not just different than the way, uh, we behave with traditional economic inputs. It's actually the opposite of it.

So, uh, I think it'll be very helpful for [00:01:00] everyone to gain an understanding of why, why that is, and be aware of it so that they can, uh, not fall prey. To the, uh, effects of reacting to, uh, investing economics, the way I'm gonna describe today, [00:01:15] because it can be very destructive to a long-term plan, uh, in and of itself.

Even though it's one of many behavioral biases or cultural biases as I like to call it. Uh, it, it, it, it can. In and of itself destroy, uh, plans.[00:01:30] 

Voiceover: Welcome to the Crazy Wealthy Podcast with your host, Jonathan Blau. Whether you're just starting out or are an experienced investor, join Jonathan as he seeks to illuminate and demystify [00:01:45] the complexities of making consistently rational financial decisions under conditions of uncertainty. He'll chat with professionals from the advice world, entrepreneurs, executives, and more to share fresh perspectives on making sound [00:02:00] decisions that maximize your wealth.

And now here's your host. 

Jonathan Blau: Let me start by saying, in traditional economics there's a term called homo economicus. And what it, what it is, is it, it it relates [00:02:15] to, um, a fictitious economic man that assumed. Uh, figuratively to be characterized by the infinite ability to make consistently rational decisions.

And for the most [00:02:30] part, when it comes to economic, uh, economic behavior and processing inputs, we do re we actually behave pretty rationally, I wouldn't say perfectly rationally. So what I mean by that is we behave in a way that's known as, uh, counter-cyclically. [00:02:45] So what that means is the demand for goods and services is counter.

To the price. So if the price is increasing, our demand is counter, it typically decreases. And if the price is decreasing, colloquially known as a sale, demand [00:03:00] typically increases. And that's pretty rational economic behavior and it's how most of us tend to behave. So our behavior it in, in, in regards to how we process stock prices is, is almost perfectly irrational.

[00:03:15] It's not countercyclical where we're. Our demand is the opposite of the price movement. It's actually pro-cyclical. Our demand moves in tandem with the price movement. So as the price of stocks is [00:03:30] increasing, going up and, and, and the more wildly it's going up, like in 1999 during the.com, uh, boom and, and ultimately bust, uh, our demand increases dramatically.

So the higher and higher the price of America online and [00:03:45] Cisco systems was going. The more we wanted to sell everything else that wasn't America, online and Cisco systems to buy more of it. Believing that as the price of these, uh, companies stocks was going higher, that the future return of [00:04:00] investing in them at the higher prices would somehow be greater than if we bought them at lower prices.

And that the risk of buying in at these higher prices was also somehow lower than the risk is would've been if we bought in at lower prices. Conversely. [00:04:15] When the price of great companies goes down and we have that sale, uh, investors, uh, tend to sell stocks. Uh, in fact, uh, one of the, uh, one of the greatest, um, [00:04:30] statements about it is attributed to Warren and Buffet.

He said The stock market is the only market in the world where when there's a great sale, the customers can't run out of the store fast enough. And there's a lot of truth to that. So what happens is when, when the stock prices are going [00:04:45] down, investors think that, that their, their risk of buying at these lower prices is increasing and that the future return they'll get from buying the earnings and the assets of these companies at a deeply discounted level, somehow will be [00:05:00] lower than if they paid higher prices and bought at a higher level.

So, so reality isn't different than what human nature thinks in this regard. It's actually the opposite. Why do we behave that way? Well, one, one of the things that happens is, at least on the [00:05:15] downside when we sell, there's something called loss aversion bias. And what that relates to is the idea that the pain of a loss to us is felt two times more than the pleasure of an equivalent gain is felt pleasurable to us.

And at a [00:05:30] certain point of loss, let's say, when the markets, in my experience go down beyond 25% or so, the investor. Perceives that as a 50% loss and then extrapolates wow. In another month or two, I could be down a hundred percent. And they actually [00:05:45] lose the ability to distinguish between temporary declines, which are the only kind that we've ever had in a broadly diversified portfolio of great companies like the Standard and Poors 500.

In fact, as I sit here recording this [00:06:00] episode today, after all of the hoopla related to the fears of the tariffs and potential recession and all of the nonsense that comes every day out of the media and the people with fancy titles from firms like Goldman Sachs and UBS, who profess to be [00:06:15] telling you what they know will be unfolding in the future, and they have no idea about it any more than you or I do.

We sit here about four to four and a half percent away or so from all time market highs. That's not to say we'll get there quickly, or [00:06:30] we won't. It's to say, as an aside, just continue to tune out the media and the people with the fancy titles. There are, the one defining characteristic about the future is there are no facts about it.

Regardless of how smart [00:06:45] or well educated, the person who's claiming to have the facts is they don't have any more facts about the future than you or I. So one of the things that causes us to react this way economically when it relates to stock prices. Also the way we think about [00:07:00] investing, we think about the stock market.

You know, the stock market's up 10%. The stock market lost 5% today. And what Warren Buffet says is he, he buys companies, he doesn't buy stocks. And every long-term investor that we deal with, we try to teach them the same [00:07:15] thing. The stock market is a place where the craziest people gather every day to do some of the craziest things in response to whatever news items are being spewed at them, uh, 24 7.

And, and we don't buy that. That is just an [00:07:30] exchange, uh, mechanism to, to trade stocks. We buy great companies and great companies values actually go in the opposite direction as of stock prices. When stock prices are declining. If you can buy Apple [00:07:45] Computer or Coca-Cola at a 30% discount or a 20% discount a month ago because of the fears of the tariffs driving stock prices down 20%, we have to recognize that great companies, uh, look at that [00:08:00] opportunistically.

They may buy back shares at that time. They may buy, uh, they may buy components of lesser. Uh, able companies to get through the crises, right? But they, they act in, on and around whatever the problem is to come out better. [00:08:15] They go into these crises or perceive crises as opportunists, and so you're buying those great companies, and I can assure you that Coca-Cola and Apple didn't lose 20% of their long-term enduring value in a month.

About a [00:08:30] month or so ago, it was a temporary decline in the price of their stock. And if you could buy it at that decline, uh, of 20%, your future investment is worth more. You're buying the future earnings of Apple or Coke and the future [00:08:45] assets at a discounted price. So there's an inverse relationship with the stock price declining and the value of the company that you're getting at that declining price.

It's such a great benefit, and don't fool yourselves into believing that, [00:09:00] well, how do I know it's the bottom? When I buy down 20%, I could be down 30. There is no bell that rings at the bottom and nobody knows. That's not the challenge of the intelligent investor. Challenge of the intelligent investor is to say, I, I know I can't buy at the [00:09:15] bottom, but I know I wanna buy before this great sale ends.

And if I don't buy at the bottom, that's okay. So I leave you with that thought. It's important also to be aware of what I call, and I term this phrase, [00:09:30] so you might not see it if you Google it, but market driven optimism, pessimism, bias. Everybody loved Nvidia two months ago. They wanted to buy it as much as they could.

It was gonna go to, uh, 6 trillion in market cap. Believe it or not, some people [00:09:45] said, meaning the value of the company was supposed to reach 6 trillion if you bought it outright from 3 trillion or so. And, and, and it went lower of course, because, uh, it, it got hit during the decline. It went from something like 160 or more, 170 or more to, [00:10:00] uh, to a hundred or so.

And it might bounce back. Uh, it's, it's on its way, bouncing back as we speak today. Uh, but it's about 120. But the point is, is the same people who loved Nvidia at 180, uh, a lot of them were selling it at when it hit [00:10:15] 120 or 110 or a hundred at some level, that loss aversion bias, feeling the pain of the loss two times more than the pleasure of against gets them out of it.

So that's what I call market driven pessimism bias. The company navidia its future prospects for the [00:10:30] next 10 years hadn't changed in a month. All that changed is the price went down, and our bias is when the price is going down, it kind of triggers something that says companies are not worth owning anymore.

It's market driven pessimism bias. We used to be optimistic about the company's [00:10:45] prospects didn't change. All that changes the price. Same thing works on the way up. A company we might not know anything about. Prices going up, everybody's talking about it. We start buying it and buying it like there's no tomorrow.

That's market driven optimism bias. We don't really [00:11:00] know that the company's prospects changed from a month ago. Most of us hadn't heard of that particular company that we're buying the heck out of a month ago. We just read about it in the papers that it was going up. So, so I, I would say that, um, try to avoid market [00:11:15] driven optimism, pessimism, bias in the big picture.

Try to have an investment plan, a date specific and dollar specific goal that you attach your investment portfolio to. You need more, as you saw in our last podcast, [00:11:30] sevens, which is stocks after inflation's, long-term return, then threes, bonds after inflation, long-term return. You need those no matter what the environment in front of you, uh, is doing.

And no matter what the stock market is doing today. And if you [00:11:45] keep that in mind, you might be able to avoid the effect of the wacky economics, uh, on investors. I hope you enjoyed this episode of Crazy Wealthy. Fix it Friday. Until next time, you can find us on Crazy wealthy [00:12:00] podcast.com. You can get us on, uh, all your favorite.

Um. Podcast menus and also on our website, fusion family wealth.com.

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