3 min read.Updated: 12 Apr 2022, 06:25 AM ISTArun Kumar, The Wall Street Journal
Don’t just act on the scary warnings of the experts and reduce your equity exposure
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Here is a story: A young captain in the army once fell down a well by accident. Some soldiers saw this, rushed to his rescue and threw in a long rope. The captain caught hold of it and the soldiers tried to haul him out. But there was a small problem. As soon as the captain neared the mouth of the well, the soldiers would let go of the rope and salute him. The captain would again slip down the well.
After this happened several times, the soldiers went and brought a major to help them. The major rushed to the spot, threw in the rope and started to pull the captain out. But almost as soon as the captain reached the top, he spotted the major. The captain immediately let go off the rope to salute the major and tumbled back into the well.
This funny story is a good reminder of how we sometimes follow authoritative figures blindly without understanding the context. Behavioural science even has a fancy name for this: authority bias. It is the tendency to blindly follow instructions or believe the views of someone in authority without thinking.
Why does this happen?
This tendency to obey and trust authority is built into the fabric of society. We are taught to respect authority from a very early age. We see authority figures everywhere as a kid – in teachers, parents, older siblings, elders, coaches, grandparents, etc. And then again as an adult - our boss, an investment expert on TV, an experienced co-worker, a person with a higher designation, a doctor, a lawyer, people with perceived power such as policemen, politicians, etc.
It is very difficult to suddenly discard this tendency. To be fair, in most circumstances, trusting a known authority figure who is an expert in their field works perfectly fine. Think of doctors, dentists, lawyers, etc.
It would be exhausting if we had to do a thorough research every time to determine if they are right.
So, the authority bias (like all other behavioural biases) is a valuable shortcut that saves us time and works well in the majority of situations.
The real issue occurs when influence from authority gradually becomes an automatic response. There are certain situations where this can backfire.
What does this have to do with investing?
Throughout your investment journey, you will inevitably come across several investment experts predicting a market crash on a regular basis.
There is a natural tendency to blindly trust and follow the views of these experts as you deem them to be an authority on that subject. This means there is a good chance that you may sell out or reduce your equity exposure fearing a possible market crash as the expert predicted.
But here is where you need to take a pause and ask a simple question: “can you name five investment experts who have consistently exited equities before a market crash and entered back at the bottom?" If you are struggling for an answer, have no worries. You already have your answer.
Let us hear what the legendary investment guru John Bogle had to say about this. “The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I do not even know anybody who knows anybody who has done it successfully and consistently."
Now comes the fascinating part.
Despite the answer being so blatantly evident, why is it that nobody questions these experts on their past track record of making such calls. Why do a lot of us still act on their scary warnings?
Simple, we all fall for the authority bias!
No doubt, respect for authority is a foundation of the civilization we live in and has numerous advantages for us. But, when there is a blind and automatic trust in all forms of authority, we may end up with a lot of serious problems especially when it comes to investment predictions.
The key is to keep reminding ourselves that “just because it comes from a reputed investor or an investment expert, it does not necessarily have to be true".
So the next time you see someone on television with a scary “market is going to crash" prediction, it is perfectly normal to feel worried given our natural tendency to follow authority.
But before you take any action, remember our young captain and his salute!