“To paraphrase Oedipus, Hamlet, Lear, and all those guys, ‘I wish I had known this some time ago.’”
Once, several years ago, we actually invested in stocks as opposed to index funds. One of those stock picks was Apple. I don’t remember the exact circumstances, but it had something to do with Apple missing earnings and the stock dropping to what we thought was a ridiculously low price, like $130/share. We talked about it for a couple of days and decided to pull the trigger. Soon after we bought the stock, it shot up to about $170.
We started getting nervous. Was it at a top? Was it going to fall again? Dead cat bounce? Was Jupiter aligned with Pluto? Was Steve Jobs scattering chicken bones?
Happy to take some profit off of the table (ooh, the Monkey Brain biases there are too many to count!), we sold at about $170. The price duly dropped to about $155, making us feel like geniuses. Then, it went up and up and up, well exceeding a four bagger.
“(*#$^(#!!!! We knew it! We knew we should have held on to that stock!” we grumbled as we kicked ourselves.
The reality is that we didn’t have a clue what Apple’s stock was going to do in the future. We were ordinary, run-of-the-mill retail investors dabbling in the stock market with our retirement funds – pretty typical of what you see in a lot of American families. We agonized over setting trailing stops, buying back in, where the limits should be, if Apple was going to reintroduce the Lisa, etc.
Yet, when the price went up and left our sell price as a speck in the rearview mirror, we told ourselves that we just absolutely, positively knew that this was going to happen.
Monkey Brain was writing our history book.
We were subjected to a very common psychological bias that, while keeping us positive, makes us think that we’re better at predicting the future than we truly are. It is called the hindsight bias, and, simply put, it means that when we see something happen, we go back and alter our mental history to tell ourselves that we predicted that event would actually happen. In reality, we had no idea if it would happen or not.
A historian suffering from the hindsight bias would write “the outcome of the battle was never in doubt.”
The heck it wasn’t! If the outcome was never in doubt, the two armies would have never taken the field in the first place! Someone on each side thought that his side was going to win, and off they went.
Why does this happen? There’s a part of our brain called the left brain interpreter which is responsible for creating a narrative of our lives. When it receives new information, it has to make that information make sense in the context of everything else it knows and has ever seen. This is easy when new information supports the general narrative. The sun rises in the east in the morning. We expected this to happen, and, thus, it conforms to our narrative.
The problem arises when something doesn’t go according to the playbook.
When that happens, our left brain interpreter often takes some artistic license to rewrite the history so that there is a coherent narrative. Oftentimes, this takes the form of the left brain interpreter telling the rest of our brain that we actually did predict something was going to happen long before it did.
If Nostradamus only had those skills, he could have done something with himself.
Letting the left brain interpreter create the narrative of our personal financial life can be dangerous business. It can lead us easily to fall prey to the Dunning-Kruger Effect, whereby we think that we’re better at something that we truly are. After all, if our brain is telling us we knew that last stock investment would go up, then, surely, we can predict the next great bull market, right?
How do we keep our inner Stephen Ambroses from including a few historical inaccuracies in our internal historical narratives?
An experiment in the late 1980s by Hal Arkes and his colleagues provides us with insight. The answer is surprisingly simple. It is to consider the opposite explanation. In practice, this means not only questioning yourself (“Did I know this all along?”) but also to come up with many other, alternative explanations for what might have happened. Try to list out all of the possible explanations for why something happened and question whether you would have thought of each of those beforehand.
The act of actively questioning Monkey Brain’s explanation of what happened and whether or not you truly knew it all along will go a long way in helping you adapt your mental narrative of history to what actually happened. Furthermore, it will prevent you from becoming overconfident about your abilities to do things where you might not be as adept as Monkey Brain says that you are.
It will save you from thinking that you know all about investing in pork snout futures before you ever commit a dime to the notion.
Have you ever thought that you knew something all along when you actually didn’t? Tell us about it in the comments below!