The Only Three Questions That Still Count: Investing By Knowing What Others Don't, 2nd Edition

Cracking the Stone Age Code—Pride and Regret

Admitting you have a problem is the first step to recovery. But you won’t know you have a problem unless you ask Question Three: What the heck is my brain doing to blindside me now? You can and will get multiple answers when you ask how your brain affects you. Some fall in the realm of your spouse, mother or psychologist. The only ones concerning us here involve market behavior. Most investing errors result from cognitive errors, the most common of which we cover here.

Look! Me Kill Huge Beast! Me Very Skilled!

As mentioned in Chapter 1, behavioralists have shown normal Americans (we’ll assume you’re normal) hate losses about two and a half times as much as they like gains.6 A 25% gain feels about as good as a 10% loss feels bad. Said otherwise, if you gain 10% over here and lose 10% over there, you feel like you’re behind. Therefore, people typically exert more effort to avoid pain than achieve gain. This is commonly known as loss aversion, sometimes referred to as myopic loss aversion, intimating shortsightedness and an overactive reaction to short-term movements. It explains many investing errors. At root, myopic loss aversion and the mistakes it leads to are about two things—pride and regret.

Our Stone Age information processors learned to do what is called “accumulating pride” and “shunning regret” as matters of survival. Imagine two hunters returning to camp at dusk. One carries a gazelle. The other has nothing but some broken ...