Feb 272017
 

New stock market highs aren’t that special. Here’s why.

Some people inaccurately believe that any time the stock market reaches a new high it must mean that we are near a peak, and it’s a sign that stock prices will probably fall soon. Many undisciplined investor may choose to pull out of the market when this happens. However doing so will almost always be the wrong decision. This is because stocks reach new highs all the time. And they usually go up even more in the following years.

This Bloomberg article explains that over the past 102 years from 1915 to 2017, the Dow Jones stock market index in the United States had hit 12 new highs every year on average. 🙂 That’s once per month. Another way to think about it is that the Dow experiences a new record high about 5% of the time. So it’s not really not that rare. 😉 The table below shows how the frequency of new highs are distributed over the decades.

If someone starts investing at age 30 and plans to live until 80, then he’ll have 50 years of time to invest in equities. Based on historical data for the Dow Jones, he will see roughly 600 new record highs during his investment duration. This is why selling stocks because we may have reached a new peak in the market is a very silly thing to do for long term investors.

Trying to sell high and buy low rarely works. Again, the facts clearly explain why this is the case. Over the same time period, (1915 to 2017), the one year average return for the Dow after it had reached an all-time high was 9%. The 3 year cumulative return was 21%, and the 5 year return was 32%. So even when stocks are at all time highs, they tend to move even higher in the years after. 😀

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Nov 282016
 

The Sunk Cost Trap

We all try to make rational decisions based on the future value of objects, investments and experiences. But the truth is that our decisions can sometimes be tainted by the emotional investments we have put into them over time. The more we are invested in something, the harder it becomes to abandon it. This is known as the sunk cost fallacy.

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It’s what a lot of gamblers do. They throw good money after bad, thinking they can turn their luck around. But it usually doesn’t work out for them. Whenever we buy stocks there’s a chance that our investments will drop in the future because the business has fundamentally changed. This is especially true for tech companies like Nortel or Nokia. Both companies fell from grace for different reasons. When investments don’t work out some investors pull out, while others continue to hold on hoping their shares will bounce back some day. Knowing which is the wiser decision can make all the difference.

In dilemmas such as this, it’s best to consider the current circumstances and opportunities. And then make a decision based on forward looking expectations. 🙂 By estimating the economic consequences of holding or selling an investment at the present time we can eliminate our emotional biases accumulated from the past.

Similarly in economics and business, a sunk cost is a cost that has already been incurred and cannot be recovered. Some business owners will mistakenly refuse to mark down their older inventory because they don’t want to sell it for less than what they paid for themselves. But the original cost of the goods is now a sunk cost, which means the money has already been paid and is irrelevant to making present decisions. Instead of focusing on selling the inventory at a loss, they should think about the opportunities cost and the best alternative strategy going forward. 😉

Some people even double down on their investments or ideologies when faced with evidence that goes against their previous actions or beliefs. This can be very self destructive if they don’t realize what they’re doing.

Sunk cost applies to many other aspects of society as well. For example, some unhappy couples feel like they’re stuck in a bad situation because they’ve already invested so much time into their relationships. But if they’ve already tried and can’t make things work then similar to investing, maybe it’s better to cut their losses and bail. As the comedian Louis CK once said, “One day one of your friends is gonna get divorced. Don’t go ‘Oh, I’m sorry!’…No good marriage has ever ended in divorce. If your friend got divorced, it means things were bad. And now, they’re better.” 😀

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Random Useless Fact:

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Oct 292015
 

The One Simple Rule to Win at Life!

People are programmed to pursue physical, psychological, and emotional security and comfort. However, if we give into our natural tendencies to always take the easy route then we won’t have a very meaningful or fulfilling life. That’s why it’s necessary to do what’s emotionally most uncomfortable.

So if we want to be rich and financially successful all we have to do is follow this one simple rule in life:

Always do the most emotionally difficult thing. 😉

This is a very profound notion and is almost counterintuitive to what our minds are designed to do. But doing the thing that’s the most emotionally challenging in any situation will actually lead to a more prosperous and satisfying life. Of course, most people do the opposite of this and try to look for the most convenient and easy way out. They believe this would give them a pleasant means to live. But ironically the pursuit of comfort and convenience often leads to a mediocre, frustrating and unfulfilled life.

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Here are some examples to demonstrate the point:

  • In business, the emotionally difficult thing for us to do is forge on ahead and take calculated risks to grow our company, even if everyone around us is being negative and unsupportive.
  • It can be emotionally hard for partners to talk about their finances, debt, and spending habits with each other.
  • When investing, it’s emotionally uncomfortable to remain disciplined and stick with a plan based on our long term goals and not be tempted to trade in and out of the markets.
  • If we want to become investment associates at ScotiaMcLeod then the uncomfortable thing to do is to attend the proper education in University and study hard.
  • In terms of saving money on food and living a healthier lifestyle it’s psychologically difficult to cook more at home, and eat out less.
  • In personal finance, it’s emotionally difficult to save at least 20% of our income and store it away in a retirement account for the next 30 or 40 years.

All of these examples are choices that we can make everyday. And those of us who choose to do the most emotionally uncomfortable thing in all these areas will experience business expansion, happier relationships, better investment returns, lucrative career opportunities, a healthier body, and an abundance of wealth in retirement. 😀 Wow. So much win for following just one simple rule.

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Sep 092015
 

Happiness is all in your head

Here’s a simple yet useful life hack we can use in real world situations. It allows us to enjoy premium experiences at huge discounts. 🙂 We often hear that a high price equals high quality. But because we are humans, the way we perceive “quality” is a physiological process, made possible by enzymes, neurotransmitters, and tiny electrical signals in our brains. This means quality is more about subjective perception than monetary value.

For example, a study at Stanford University conducted a wine tasting experiment. Volunteers were given two types of wine to drink in equal portions. As they were served, the test subjects were “told” the price of the wine they were tasting. One costed $10 per bottle, and the other was $90 per bottle. But what the volunteers didn’t know was that both the cheap and expensive samples of wine were actually from the same $10 bottle, lol. Meanwhile an MIR machine scanned their brains to measure real-time blood flow. The results were almost mind blowing. 😀

The subjects’ brain scans showed that there was more blood activity in their prefrontal cortexes when they drank the sample that they thought was from a more expensive bottle. The prefrontal cortex is the part of the brain that makes us feel pleasure.

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In other words, the test subjects’ brains experienced greater delight when they thought they were tasting something more expensive, even though it had always been the same cheap wine. ? The brain can easily mistake high price for high quality, even when that’s not the case.

So the next time you want to drink wine, just buy the cheap stuff and pretend it’s really expensive when you drink it. 🙂 Pour some for your friends when they come over. Describe the wine to your pals using venerable words such as premium, estate, exceptional quality, etc. Your guests will think that they are drinking from a very expensive vintage. 🙂 And they won’t simply think it tastes like premium wine. It actually would taste like premium wine to them for all intents and purposes, as far as their reality is concerned. Just be careful to not drink too much yourself and accidentally reveal that it’s really just a $10 bottle.?

Brand-name drugs and generics both use the same active ingredients. Since we understand how our brains can play tricks on us, we can choose to buy generics to get the same effects as the brand-name label, but pay less money. 🙂

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May 252015
 

Many people are unaware that they are victims of the Dunning-Kruger effect, which is a cognitive bias wherein unskilled individuals suffer from illusory superiority, mistakenly assessing their ability to be much higher than is accurate. Conversely, highly skilled individuals tend to underestimate their relative competence, falsely assuming that tasks which are easy for them are also easy for others. 😉 A study by David Dunning and Justin Kruger of Cornell University concludes: “The miscalibration of the incompetent stems from an error about the self, whereas the miscalibration of the highly competent stems from an error about others.”

Often when we’re bad at something we don’t even have the knowledge to know how bad we are. We witness this illusory superiority every day. 80% of men and women drivers surveyed in a study said they would rate themselves as above average drivers, lol. 😆 Boats become grounded when their captains overestimate their crew’s abilities. Confidence is good, but overconfidence can sink the ship.

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Our financial situations can sink as well if we suffer from the Dunning-Kruger effect. Many of us lack the basic financial knowledge to even realize that we’re making mistakes. It’s this lack of understanding about things like the stock market, compound interest, and inflation that can lead us to erroneously believe we’re making the right decisions when in reality we’re only deluding ourselves and setting us up for potential failure.

Overconfidence is the most dangerous form of carelessness. And when it comes to our money we can’t afford to be careless. So learn something new everyday. An investment in knowledge pays the best interest, after all. Gain experience to combat ignorance. Become better at managing money. And in the meantime, heed the wise words of the ancient sage, Confucius: “Real knowledge is knowing the extent of what you don’t know.” 🙂

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Random Useless Fact:

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