The Fault Really Is In Ourselves

This post was written yesterday afternoon before the Asian session opened and silver dropped. This is relevant further down in the post.

Barry Ritholtz thinks Robert Shiller's latest article for the NY Times has taken a wrong turn in terms of Shiller saying that too few people saw the financial crisis coming and that because of this there was no avoiding it or otherwise reducing the impact. Barry says there were quite a few people warning of the impending meltdown including, ahem, Shiller.

Later in the post Barry refers back to a list of ten factors that he mentioned in 2009 of why the crisis was missed by so many including structural issues at brokerage firms, political biases and most interesting to me that "economic analysis ignores human irrationality." Much of economics and portfolio theory gives people far too much credit for being rational and I think the evidence to the contrary is overwhelming.

There has been a mini-meme lately about left-brain/right brain that ties into this. If I have it straight our left brain hinders us from thinking about longer term consequences and our right brain allows us to think about longer term consequences and for whatever reason far more market participants and people working in the industry heed their left brain and go for the faster buck now with not enough regard for the consequences (apologies if I have left and right mixed up but the point is the same).

I believe I have addressed this before in talking about how too many people forget the pain of large declines or repeat certain behaviors that hurt them before like loading up too much on whatever is hot but never having a plan for reducing exposure. At some point gold and silver will correct, maybe it starts today or after another 300% rally, and knowing ahead of time when it will happen means much less than being cognizant of an inevitability, aware of the size of your position (if you have one) relative to your portfolio making sure that a large decline doesn't hurt you.

When I've made points like this recently there have been some comments, mostly on Seeking Alpha, that believe gold and silver will keep going up as long as the US government and Federal Reserve keep fill in the blank. Yes, that is the fundamental argument and it is very strong but that does not mean the price can't drop a lot for a couple of months in the midst of all that is going on. I would point out that there was similar sentiment, albeit with different details, around internet stocks and housing (try to remove hindsight bias). This is not an attempt at a prediction, just an effort to avoid being hurt by some similar behavioral aspects that are repeating today.

The encouraging thing here is that people can train themselves to overcome most of these types of issues. One way to do this is to map out ahead of time. This can pertain to portfolio weightings, defense strategies and making sure you recognize when certain behaviors from past events are repeating whether this refers to your own behavior or that of the market in general.

If you are just a regular person whose objective really is about having enough money when you need it (and you have the self awareness to realize this) then it should be much easier for you to listen to your right brain, focus more on your longer term and recognize the types of things, and there are a lot of them, that do people in or otherwise set them back for many years.