A Better Attitude for Better Investment Returns

How Rosy Retrospection and Declinim Biases Impact Investors

Many of my favorite conversations occur over a glass of bourbon and a hand-rolled cigar. During a recent discussion with an old friend, I was asked why the stock market continues to rise despite the wall of worry built by a global pandemic, racial unrest, and the divide over differing politics.

My initial reaction was to repeat common economic talking points about the Federal Reserve’s commitment to providing a backstop for the U.S. economy or the fiscal stimulus passed by congress. Neither seemed adequate. We discussed this at length and once my cigar was smoked to the nub and my glass all but empty I went inside without a satisfactory theory.

Over the next several days I thought more about that conversation. Our country has experienced tumultuous times throughout its existence, and we’ve emerged each time, usually improved, but still far from perfect. One glance at a long-term chart of the U.S. markets shows decade after decade of positive returns. When people reflect on “the good ole days” they recall wonderful stories of the past much more vividly than they remember the serious issues that plagued that era. And many people don’t see the future as positively as they remember the past.

Why is this? After doing a little digging I concluded two very related cognitive biases, rosy retrospection, and declinism are largely responsible.

Rosy Retrospection, appropriately named, is the tendency to remember the past more favorably than it occurred. Some describe this as a defense mechanism or mental health tool since constantly recalling negative experiences can damage one’s mental health. Rosy Retrospection is most commonly used to describe an individual’s view of past events from their own lives, often their childhood, but it’s similar to another cognitive bias that examines how people view the world, society, or institutions, declinism.

Psychology Today took a look at declinism in America to examine why the view is that America is declining is so popular. They examined the economy, race relations, gender equality, LGBTQ rights, healthcare, and other relevant topics to show that things might not be as bad a commonly believed. In fact, America may be significantly better. Despite improvements in many areas, some continue to see America in a downward spiral. That’s not to say we don’t continue to face issues as a society, but perhaps the future is not as bleak as it appears.

What does this have to do with investing?

The stock market is essentially the world’s largest pari-mutuel system with the pricing mechanism acting as odds for future outcomes for various companies, industries, sectors, asset classes, countries, etc. If the bulk of the population views the future through an overly pessimistic lens, the market may be vastly underpricing future growth and potential. Knowing these biases exist can be useful in coping with overly negative noise in the media and focus your attention on evidence about the world around us and the future. This can lead to better long-term investment decisions.

Let’s take a look at the stock market returns during some of the difficult periods of America’s past: **

1. World War II: America entered World War II after Japan’s infamous surprise attack on the U.S. fleet on December 7th, 1942. American’s watched anxiously as our European allies were overrun but remained reluctant to interfere. However, the attack on Pearl Harbor ended any notion that America could remain uninvolved. I can only imagine the stress and fear Americans felt as the world became more and more engrossed in a deadly war. Despite a raging world war and an uncertain future, the markets returned almost 47% from 1943 to 1948. This, of course, is largely due to the war ending, and America emerging as a world power. Still, it paid to be optimistic during a difficult time.
2. 1968: I didn’t live through it but I commonly think of the late 60s as a difficult and pivotal time in our nation. The Vietnam conflict raged on despite fierce opposition and the growing concern of a stalemate. The great civil rights activist, Martin Luther King Jr., was assassinated in Memphis, throwing fuel on the civil rights movement. And while campaigning for President of the United States, the young and highly regarded Bobby Kennedy was killed in Los Angeles. And that was just the first half of the year. It’s easy to understand the widespread worry about our country’s future. Yet, from June 1968 to June 1973 the markets returned over 4%. Meager, yes, but positive nonetheless.
3. Watergate: the Watergate Scandal began as an attempt to cover up a break-in and culminated in the resignation of the leader of the free world. I’ve seen political scandals in my life but it’s hard to imagine the division that existed during the Nixon administration as the Watergate cloud grew darker over America. In an address to the public, the President announced his resignation on August 8th, 1974. In the following five years the market returned over 40%.
4. September 11th: this is the only of the mentioned events I lived through. As a high school student, I couldn’t understand what happened on September 11th, 2001. I didn’t understand the attacks nor did I predict how they would impact my future or the world. But I was scared. Over and over again I was told that the world would never be the same after that fateful day. And it wasn’t. But we continued, as we do and from September 2001 through September 2006 the market returned over 26%.

$1,000 invested in the S&P 500 in 1929 would be worth over $150,000 today.

Today we’re dealing with the trials and tribulations of our time, which will soon be the challenges of the past. Future generations will tackle new, unforeseen problems, and tussle with the demons we never quite defeated.

Despite the natural tendency to be anxious, worried, and scared about a world in decline, I’ll continue to invest in innovation, progress, and solutions, as I believe these opportunities are underpriced as long-term investments.

* This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from James Vermillion, and all rights are reserved.

**Return calculations from https://dqydj.com/sp-500-return-calculator/.

Originally published at https://www.vermillionprivatewealth.com on December 14, 2021.