Cycles of Dumb: Part 3
By Gary Silverman, CFP®
We’re on the third week of a look at what makes smart people do dumb things (at least with investments). Last week I introduced the Recency Bias where we extrapolate far into the future what has been happening recently. Back at the start of the 1990s this meant that people began to think stocks would keep going up because they had been going up.
As I mentioned, at that time stocks were in the beginning phases of a bull market that didn’t end until the tech crash of 2000. Even with the pause in 1994 there was great optimism in what stocks could do. This created another danger: Overconfidence. Investors living in the ’90s began to see themselves as invincible. Since they knew this couldn’t just be luck, it must have been their investing prowess. Think of the recently retired Garrison Keillor’s Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.
As those first “above average” folks began telling their friends over the next several years how they were making 10-20% returns on their money, others joined the ride up. That made things go up even more. This is the third danger/dumb point: Herd Mentality. If “everyone” is doing it (whatever it is) successfully, then by golly you’ll do it too and be just as successful.
In the late ’90s this combination of Recency Bias, Overconfidence, and Herd Mentality combined to produce an optimism not seen since the 1920s. This turned into excitement and set the stage for the tech bull run that ended up concentrated in Internet-linked companies. That these companies weren’t actually making a profit didn’t matter…they were gaining market share and their prices were soaring.
Euphoria reigned the day. People were quitting their jobs to do day-trading. Others were mortgaging their homes to buy into ticket symbols—they couldn’t actually tell you the name of the company or what it did…only that they knew it would double in value that year (after all, it had been gaining for a while, right?).
Then came the year 2000. The world was a little worried about Y2K Armageddon (Millennials, ask your parents what that was all about). But the electricity stayed on and airplanes kept flying. Yet the beginning of the end was already on its way.
Most didn’t notice at first. This, ladies and gentlemen, was the market top and few saw it. For while the ’90s constituted the greatest stock bull market in U.S. history, it did have a few hiccups along the way. But so-called seasoned investors (people thought they were seasoned after about a month) learned that any pull-back was just a not-to-be-missed buying opportunity. Euphoria, after all, tends to wipe out reason. It is optimism on steroids. But some began to feel a bit anxious as tech companies shifted from meteoric rise to a slowly accelerating fall.
Where this all led to next week.
This article was published in the Wichita Falls Times Record News on September 4, 2016.