Are you an optimistic or pessimistic investor?
Investing: Optimism vs Pessimism
If you are a long-term investor, chances are you are a fairly optimistic person; at least you believe the future will be mostly better than the present. If not, why would you forgo the pleasure of spending money today if you did not believe it could become much more in the future?
Yet even the most optimistic investor gives some attention to predictions of impending doom. We have to. Genetically we have to because our brains are hardwired to scan for threats. That’s why most people take a step back when they see a snake cross the trail. It’s why the evening news reports 80% negative news. We are programmed to pay attention to things that might harm us. In the modern world, wolves may not be top of mind for most people, but certainly our financial future is something on which we place great importance. Chapman University conducts an annual poll to rank Americans’ fears. Financial ruin or running out of money has always been in the top 10. Side note, last year’s #1 fear was corrupt government officials (read more) Zombies and Ghosts were #86 and #88 respectively.
Along with genetically being programmed to pay attention to potential threats, what I find most interesting, from a psychological point of view, is that pessimism often just sounds smarter than optimism. Particularly in discussions of economic and financial matters.
“Don’t panic, the market always comes back”. It has, and then some, but that advice can sound pollyanna to someone whose account has lost 25% or more. Optimism often sounds like the person offering advice is relying on luck. Pessimistic advice, on the other hand, often sounds like someone is trying to help you. “The dollar will soon be replaced as the global reserve currency, countries like China, Russia and Brazil are actively trying to exclude the dollar from international trade. With more debt than annual GDP, our nation has never faced this kind of threat since we achieved global dominance. I’d think twice before putting more money in the stock market.” Pessimism contains facts too, making it seem well thought out. This person is looking out for my best interests.
I think some amount of pessimism is healthy. Every quarter when we set the allocation for our risk-based investment strategies we ask ourselves, “what are the risks?” There are always risks. It has been said, the real risk is what is left after we think we have accounted for everything. The problem lies in if we are always looking for reasons for impending doom. None of us ever have a complete picture of the world. This fact is magnified in economics and investing. Our view of complex economies is incomplete, yet our mind fills the gaps with stories we create that we believe make sense. “Mortgage rates have risen above 7%, real estate will be an unattractive asset class in 2023” yet Home Builders have been one of the best performers in 2023.
Rather than try and predict what asset class faces imminent doom, I think it makes more sense to act like a true long-term investor and find undervalued asset classes in which you can be patient until the market acknowledges their value. Small cap stocks seem to be that asset class to many analysts right now. The Russell 2000, which is a small cap index, is trading at multiples half of what they were just a year ago (read more). Small cap stocks historically are priced higher than large cap stocks because it is typically easier for small cap stocks to grow than giant mature companies that have already saturated most of their addressable market. Yet compared to their history, large cap stocks are trading much higher than their historic price to earnings multiples. The last time small cap stocks trailed the performance of large cap stocks by this much was in the first few years of the 2000s. Small cap stocks went on to outperform large cap stocks by over 50% (2003 to 2008). Paraphrasing Warren Buffett, the key to being a successful investor is patience and the willingness to appear wrong for a period of time.
Please note: This content is not a direct recommendation for investment. Investing involves risk including the potential loss of principal. Not all investments are suitable for all people. Crosby Advisory Group, LLC is a registered investment advisor in Ohio, Florida, and Texas.