Stock markets, currencies and commodities all rise and then they fall, and then they do it all again… and again.
Despite this predictability, most investors are caught off guard by these market cycles. A market was moving in one direction… and then the cycle moves on to the next phase and everyone is surprised. It’s such a surprise because of “status quo bias”.
The status quo bias
We tend to think that things are likely to remain the same – because our most recent memory is of them being a certain way.
For example, a few years ago, I started going to a sushi restaurant a few blocks away that offered an all-you-can-eat buffet. It was my go-to venue for a great lunch deal – lots of sushi for a very reasonable flat price. So every few weeks, I’d settle in to my favourite table, gleefully ignore the (woefully overpriced) a la carte menu, and happily inform the waiter that I’d be having the buffet.
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But one day, when I went in expecting cheap sushi for lunch, the waiter told me: Sorry, sir, we no longer have that promotion. And he nodded to the menu on the table.
I felt a wave of shock peppered with disappointment wash over me. Past experience had led me to expect that this time – like previous visits – I’d get the buffet. Why wasn’t it available? What was different now?
I assumed that what happened before… would continue to happen.
It’s the same in investing.
Investors buy a stock that’s been steadily rising in price because they expect it to continue going up. Investors expect a bull market to continue because, well, the market has recently been rising. Status quo (which means “the state in which” in Latin) bias helps them forget about cycles.
Investors fall victim to status quo bias because they believe the four most dangerous words in investing: “This time it’s different.” This time, the market will continue going up… and this time the hot stock will continue to rise.
Of course, nothing is different. The cycle always prevails.
Imagine a stock that pays you 100% income on your money every year… and continues to do so for the rest of your life. $1,000 in savings would pay you $1,000. $10,000 would pay you an extra $10,000. $100,000 would pay you $100,000. And again, that’s every year. We never thought an investment like that would be possible…
How you can protect yourself against status quo bias
It’s one thing to intellectually recognise that a cycle will end at some point. It’s another thing to do something about it.
It turns out that the best way to beat status quo bias is to procrastinate.
Studies on behavioural economics have shown that if asked to make a particular decision about something by the end of the day, people are more likely to decide to leave things unchanged. Change is hard, and the status quo is easy. And when you don’t allow yourself time to make a decision, it’s easier to keep things the same.
But when people are asked to make a decision by the end of the week, they’re more likely to think carefully – and make a decision based on facts, rather than the comfort of the status quo. This suggests change comes more easily if you have time to get used to it.
So the next time you think that this time is different… wait a bit. You might realise that, in fact, it’s never different. That can be difficult to accept when markets are going up. But it’s a relief if markets are going down.
Publisher, Stansberry Pacific Research