It pays to be optimistic. Literally. A $100 investment in the S&P 500 in 1900 has increased 12,520,825% at today’s price¹. History shows us that humanity has largely been a story of constant progress and betterment. But that doesn’t stop us all too frequently defaulting to pessimism. Optimism is uncommon. There are many justifiable reasons we succumb to pessimism's lure (and it's not because we are all mad). Knowing what these are can help us to not fall prey or even take advantage when these emotions arise.

I have outlined two of these below, but for readers eager to learn more, there is a brilliant chapter in Morgan Housel’s The Psychology of Money titled The Seduction of Pessimism, where you can do just that. My hope is that the next time you hear Baron Rothchild’s “Buy when there is blood in the streets”, or Warren Buffett’s “Be fearful when others are greedy. Be greedy when others are fearful”, you will be reminded of this article. 

One is that pessimism simply sounds smarter. It grabs our attention, and it sounds like someone trying to help you. Optimism on the other hand, with its cheery tone, is taken less seriously and is often met with a dubious eye. The news industry, of course, knows this. Why do you think headlines and stories are often about bad things happening, despite relative peace for the past 80 years? To show how optimism sounds less plausible, Morgan offers an example of a hypothetical news article in Japan after World War II. Japan was totally wrecked in every way imaginable following the war. He asks us to imagine the following article:

“Chin up, everyone. Within our lifetime our economy will grow to almost 15 times the size it was before the end of the war. Our life expectancy will nearly double. Our stock market will produce returns like any country in history has rarely seen. We will go more than 40 years without ever seeing unemployment top 6%. We will become a world leader in electronic innovation and corporate managerial systems. Before long we will be so rich that we will own some of the most prized real estate in the United States. Americans, by the way, will be our closest ally and will try to copy our economic insights.”²

This is, of course, exactly what happened in Japan in the years after the war. But consider reading a similar article in relation to the UK today. You would think it is utter fantasy.        

The next reason comes from the late Daniel Kahneman (who we wrote about recently, in another article) and Ames Tversky and their concept of loss aversion. Simply put, “losses loom larger than gains”³. We are by nature more averse to losses and tend to avoid them. There is an evolutionary history behind this. An organism that treats threats with more urgency than opportunities has a greater chance of survival and reproduction. The rise in interest rates over the past couple of years offers a timely example. Given the choice between investing in a product that has a 50% chance to make 12% and a 50% chance to make nothing, or a bank account that guarantees 4.5%, which would you choose? Most would, and many have, chosen the second, despite the higher expected value of the first option. 

Fear and its counterparts can be some of the most destructive emotions we face in life. This goes beyond just investing. Think about it. How many examples can you think of where fear holds us back, and to our detriment? Whether it's an investor waiting on the sidelines because of war or geopolitical tensions and missing the many years of positive returns, or a budding entrepreneur not starting a business through fear of failure and not creating the next Microsoft, pessimism, fear, and self-doubt permeates through every facet of our lives. It is the optimists, however, that win out more often than not. Morgan closes the chapter with the following:

“Volatility and loss amid the long backdrop of growth is the price of success and we must be willing to pay it.”⁴

We should do our best to remind ourselves of that whenever we can.

Sources:

1. https://www.officialdata.org/us/stocks/s-p-500/1900
2. Morgan Housel (2020) - The Psychology of Money - p179
3. Kahneman, D. & Tversky, A. (1992). "Advances in prospect theory: Cumulative representation of uncertainty". Journal of Risk and Uncertainty. 5 (4): 297–323.
4. Morgan Housel (2020) - The Psychology of Money - p187