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S p e c i a l R e p o r t J a n u a ry 20

How to Keep a Foolish Mindset


Morgan Housel is a longtime Motley Fool columnist who focuses on big-picture
issues in the economy and how they affect investors lives.
With his Motley Fool Mindset series, Morgan brings you our best guidance on knowing yourself as an investor, making sense of the macro matters in the world around
us, and mastering the concepts that will put and keep you on the path to Foolish
success.
Heres a special report with several essential articles that will help you stay Foolish
during times when it looks like the market has lost its way.
In this report:

What Happens Next

Keep calm by keeping perspective todays pain can lead to tomorrows gains.

Get Ready for the Next Bear Market

What you invest in wont matter unless youre willing to stay invested.

Our Foolish Investing Edge

Dont worry what others think in the short term wealth comes from a long-term focus.

Battle Your Brain: How to Become a Less-Biased Investor

Successful investing is less about what you know and more about how you act.

What Happens Next?


Keep calm by keeping perspective history shows that todays pain can lead to tomorrows gains.
The stock market has increased almost 300-fold
over the past 60 years. Thats an astounding rate
of growth captured in a timespan shorter than the
average life expectancy.
But heres whats amazing. During that period of
growth, stocks spent the vast majority of the time
well off their all-time highs.
Investor Michael Batnick put together this great
chart for me, showing the percentage of the time
the S&P 500 has been down 5% from its all-time
high (gray), down 10% from the high (blue) and
down 20% from the high (red):
Crunch all the data, and youll see that the
market is at an all-time high just 7% of the time. In
fact, the market is:

The important takeaway is that short-term


market declines do not preclude big long-term
market returns.
Think about it: During a period when stocks rose
300-fold, they were below their all-time high 93% of
the time.
If you want something better than average
in investing (or most things in life), you have to
be willing to pay a price. For stocks, that price is
enduring common-but-uncomfortable short-term
volatility. Since not everyone is willing to deal with
that uncertainty, there is opportunity for those who
are. And thats exactly why stocks do well over the
long run because we occasionally have months
like this.

0% to 5% below its all-time high 36% of the time


5% to 10% below its all-time high 15% of the time
this is where we are now
10% to 20% below the all-time high 22% of the time
20% or more below the high 21% of the time

This article was originally published in August 2015.

the market falls, but the market rises

The Motley Fool January

Get Ready for the Next Bear Market


What you invest in wont matter unless youre willing to stay invested for the eventual recovery.
Heres what I think is the most important topic in
investing: How you behave during bear markets.
This one topic will likely have the most influence
on how you perform as an investor over the long run.
Why? Because you can be the best stock picker in
the world, capable of finding tomorrows winning
businesses before anyone else. But if you let your
emotions get to you and sell stocks when a bear
market arrives, none of it will matter. You will fail
at building long-term wealth.
Prepare Now to Make the Right Move
I looked at what happens in the five years after the
market drops by a lot. Historically, the more the
market has dropped, the higher the odds it will
rise over the next five years and the larger
those subsequent gains are likely to be.
After a 10% drop, stocks are higher five years
later 86% of the time. The average return during
that period is 51%, which is great. If the market falls
20% from its all-time high, historically its been
higher five years later 89% of the time. And if the
market were to fall 40%, there has never been a time
in history when it wasnt higher five years later.
History is under no obligation to repeat itself,
of course. But successful investing is about being
present when the odds of success are in your favor.
And after bear markets, the odds of future success
rise substantially.
This is so important for investors to understand
because no matter how persuasive this data may be,
the emotional urge during bear markets is to think
the opposite.
Losing money is painful. Your brain hates pain,

after the fall


odds that the
S&P 500 is
higher in 5 years

average subsequent 5-year return

all periods

80%

47%

after a
5% drop

81%

48%

10% drop

82%

51%

15% drop

86%

20% drop

89%

61%

25% drop

90%

63%

30% drop

94%

78%

35% drop

99%

78%

40% drop

100%

57%

102%

and so bear markets can cause an overwhelm urge


to sell stocks after theyve dropped. If you understand the historical data, this is the least-rational
thing you could possibly do. But its what we see
from investors around the world every single time
stocks decline.
Were not into trying to predict when the next
bear market will come. Nobody can do that. But we
know it will come, and preparing yourself now for
the inevitable next decline is one of the most helpful
things any investor can do.
The pain of the past few weeks sets us up for
higher, and more probable, future returns. It could
easily get worse from here. But the worse it gets, the
higher the odds of future success.

Volatility scares enough people out of the market to


generate superior returns for those who stay in.
Wharton finance professor Jeremy Siegel

The Motley Fool January

Our Foolish Investing Edge


Dont worry what others think in the short term wealth comes from a focus on the long term.
Last spring after one particularly red day in the
market, Chris Hill, host of The Motley Fools radio
show, received a heckling email:

But that was even true. In fact, Chipotle Mexican


Grill (CMG) had fallen more than 7% that day.
Some investors look at this drop as proof that our
admiration and ownership of Chipotle a favorite
across many Foolish services and advisors was
proven wrong. Like we made a mistake. Egg on our
face. Shame on us.
We dont think about investing this way, and
understanding why were OK owning a stock that
drops 7% in a single day is paramount to understanding why some investors have a terrible experience in
the market while others build long-term wealth.
Heres how I explained our faith in Chipotle and in investing
Foolishly in April 2015. The stocks returns have gone up
and down (and will surely do so again) since then.

Motley Fool Rule Breakers first recommended


Chipotle in January 2007. The stock has since gone
up nearly 900%. Tom Gardners Everlasting Portfolio
recommended Chipotle in December 2012 and has
earned a 69% return. Those results are phenomenal.
But Chipotle has been an utter roller coaster
since weve owned it.
I crunched some numbers to show what I mean:
Since January 2007, Chipotle has closed down 5%
or more 47 times.
The stock has been down at least 5% in 12% of all
one-week periods. Thats more than 1 in 10 weeks.
Its been down 10% or more in 1 out of 5 six-month
periods.

And its dropped at least 20% in 1 out of every 7


six-month periods.
The stock fell 73% in 2008. It recovered, only to fall
another 40% in 2012.
It recovered again, then dropped another 10% in 2014.
Through it all, Rule Breakers increased its money
nearly tenfold.
What would have happened if we felt like we
made a mistake every time the stock fell 5%? We
would have never not once enjoyed marketbeating returns in any stock for more than a few
months at a time.
Every investor should understand their edge. If
you dont have an edge, how you can expect to beat
the market?
Invest Like a Fool
Let me tell you what I think our edge is: We dont
mind getting emails like the one Chris received. A lot
of investors share the views of the guy who sent the
email, but we dont. No one around here cares much
about what a stock did in any given day, or even
month. We care about long-term results. If were
truthful and honest at implementing this mindset,
we will stand apart from the crowd and not get
caught up in the emotional traps other investors do.
Thats our edge. Its simple, but its so powerful.
Are days and weeks like this fun? Not really. No
one enjoys watching their wealth decline. But we
know theyre going to happen. And we know that
what happens to one stock in any given day even
any given year is largely irrelevant to meeting
long-term goals.
Short-term thinking is one of the biggest dangers
in investing. Its a surefire path to ruining your
experience as an investor. If you can avoid it you
will do better than the vast majority of investors,
amateur or professional.
The Motley Fool owns shares of Chipotle Mexican Grill.

The Motley Fool January

Battle Your Brain: How to Become


a Less-Biased Investor
Successful investing is less about what you know and more about how you act.
Youve probably never heard of Mohnish Pabrai. And
theres a reason for that.
Pabrai is one of the most successful investors of
the past 20 years. One dollar invested in his hedge
fund in 2000 would be worth more than $7 today,
versus $1.78 in the S&P 500. And thats after my
ridiculous fees, as Pabrai jokes.
Why have you never heard of him?
I first learned of Pabrai from a friend in 2007.
There was almost nothing written about him at the
time. He wrote a book in 2006, but no publisher was
interested, so he self-published a handful of copies.
I discovered that Pabrai lived near me, gave
him a call, and asked if I could interview him. He
graciously agreed.
I came to his office expecting to see a normal
hedge fund arrangement: dozens of well-dressed
analysts, rows of Bloomberg terminals, TVs tuned
to CNBC.
But I found something completely different.
Pabrai manages more than half a billion dollars
entirely by himself. He became one of the worlds
best investors with a desk, a filing cabinet, and a nap
room. I have a hard time getting past the day without the nap, so the nap is a must, he says.
Pabrai was the antithesis of most hedge fund
managers. This made me even more fascinated in
his success. So I asked him what his secret was.
Control over my emotions, he said.
Thats it? I asked.
Its huge, he said. Its all you need. Youd be
surprised.
Pabrai isnt a successful investor because he has
more information than everyone else, or because
hes better at math than everyone else, or because
he knows more about business than everyone else.
Hes successful because he has won the battle with
his brain.

The reason you probably havent heard of Pabrai


is because he has such control over his emotions
that he has little desire for fame. I dont think he
feels the need to be on CNBC or have his face on the
pages of The Wall Street Journal. Hes emotionally
grounded enough to be content reading at his desk.
Control Yourself
Successful investing has little to do with what you
know and almost everything to do with how you
act. This report will attempt to be instructive. How,
exactly, do you overcome these flaws? How do you
become more like Pabrai?
A few years ago, I interviewed Daniel Kahneman,
a Princeton psychology professor who won the
Nobel Prize in economics. I asked him if humans
can overcome biases or if they are deeply ingrained
flaws that were stuck with whether Pabrai is a
freak of nature, essentially.
They can be partially overcome, yes, he said.
There are ways people can become better thinkers.He elaborated on how this applies to investors:

I think it is very important not to encourage


people to do things that are likely to expose
them to regret. The potential for regret is
something that investors should know about
themselves.
How much am I going to suffer if this decision
of mine doesnt work out? How easily am I going to think, Oh, I made a mistake? How prone
am I to think that I made a mistake? Its a big
variable, and really worth discussing, I think,
with clients because part of the inability to
stay the course ... you have to inoculate yourself
against regret.
At its core, overcoming cognitive biases is about
inoculating yourself against regretful decisions.

The Motley Fool January

Battle Your Brain: How to Become a Less-Biased Investor


This is, of course, easier said than done. And tackling this subject for every personality would be
impossible.
I see three areas that consistently cause investors huge amounts of regret:
Where you get your information
Who you talk to about your investments
How you keep yourself accountable to your goals
Lets go through each one.
1. Where You Get Your Information
Twenty years ago, only a few media outlets dominated the dissemination of financial information:
The Wall Street Journal, New York Times, an early
version of CNBC, and Louis Rukeyser.
Today, those outlets make up a minuscule
fraction of whats published (and Rukeyser is no
longer with us). Financial media has exploded, with
hundreds of outlets providing thousands of opinions
each day.
Though thats mostly a good development, it can
also be dangerous if you dont know how to use it.
The truth is that, while news coverage has grown
exponentially in the last two decades, the amount
of news has not. Todays financial media offers
copious amounts of drivel, gossip, rumor, innuendo,
and nonsense. As author Nassim Taleb once wrote,
The calamity of the information age is that the toxicity of data increases much faster than its benefits.
To avoid bias, therefore, it is vital that you as an
investor know how to navigate this world.
Finding reasonable information is about more
than using reputable sources. Consider this quote
from a December 2008 front-page Wall Street
Journal article:

Igor Panarin posits, in brief, that mass immigration, economic decline, and moral degradation
will trigger a civil war next fall and the collapse
of the dollar. Around the end of June 2010 or
early July, he says, the U.S. will break into six
pieces with Alaska reverting to Russian

control. California will form the nucleus of what


he calls The Californian Republic, and will be
part of China or under Chinese influence. Texas
will be the heart of The Texas Republic, a cluster of states that will go to Mexico or fall under
Mexican influence. Washington, D.C., and New
York will be part of an Atlantic America that
may join the European Union.
Keep in mind, the economy was falling apart in
December 2008. And this was The Wall Street
Journal, Americas most prestigious financial news
source, so people took this seriously. You may have
yourself.
After years of trudging through the financial
media, heres how I would dissect a story like this
today to ensure it doesnt bias my behavior.
(a) Who Is Igor Panarin?
A quick search would have shown that Panarin, a
Russian political scientist, has a history of making
outlandish predictions. He first presaged the same
six-part American disintegration in 1998. In previous
years, he augured what he called the New British
Empire, the New Eurasia, the Eurasia Union, and
a new global currency none with any success.
This is vital to know, because you instantly
realize that this prediction tells you more about
Panarins personality than his objective analysis
of the economy. Predicting collapse is just what he
does. Its who he is.
If you get to know enough financial pundits,
youll find this is a recurring theme. People who are
currently bearish on stocks Peter Schiff, Marc
Faber, John Hussman have by and large been
bearish for decades. Bulls like Jeremy Siegel have
been bullish for most of their careers as well. Its a
reflection of their personalities.
After you learn the background of pundits and
analysts, you are less likely to take them as seriously
as you did before. You will learn that most analyst
are athletes in a full-contact sport called punditry.
Realizing this helps prevent you from being biased
by their views.

The Motley Fool January

Battle Your Brain: How to Become a Less-Biased Investor


(b) If Panarin Is Right, What Should I Do About It?
Lets say America is about to break apart into six
pieces. Or lets say the analyst predicting a market
crash is right. What should you do about it?
For most long-term investors, the answer is
almost always nothing.
If you need to sell stocks next week to cover your
mortgage, knowing if the market is going to crash
next week is vital. If youre investing for the next 15
years, what the market does next week is irrelevant.
If you are a day trader or hold short-term options,
whether a stock beats quarterly earnings is really
important to you. If youre a long-term shareholder,
it shouldnt be at all.
The worst trait of the financial media is its
inability to recognize that investors have different
time horizons, which makes it impossible to offer
blanket advice. Yet it does all day long. Very few
sources of information come with a warning that
says This advice is intended for a 62-year-old
investor with at least 10 years to invest. Instead,
its given as The market is going to crash and you
should sell. The truth is that the person writing
this information has no idea who you are, what your
goals are, or how long you have to invest. Even if
their prediction turns out to be accurate, you should
not assume it is applicable to you and your goals.
Because it rarely is.
To prevent media from biasing your financial
decisions, my sincere advice is: Consume less
of it. It does not have to be more difficult than this.
In his book The Information Diet, Clay Johnson
writes:

Its not information overload, its information


overconsumption thats the problem. Information overload means somehow managing the
intake of vast quantities of information in new
and more efficient ways. Information overconsumption means we need to find new ways to be
selective about our intake. It is very difficult, for
example, to overconsume vegetables.

We also have to distinguish between information


and analysis. Company annual reports, economic
data, and conference call transcripts have information. Pundits and analysts provide analysis. In
my research, successful long-term investors favor
information over analysis by at least a 10-to-1
margin. Most people are good thinkers, but are
gullible to being persuaded by pundits who are
trying to grab attention. If you go for the information and ignore the pundits, you will have a better
time coming to smart, unbiased decisions.
Stock picks, board posts, and articles within
The Motley Fools community are a great resource
because they are the closest bet you have to reading
material that aligns with your goals, strategy, and
investment philosophies. They are as close as you
will get to vegetables.
Outside of the Fool, I would advise favoring
books over articles. There are lots of bad books and
lots of great articles. But books are more likely to
be thought out, thorough, fact-checked, and edited
than most articles. They are also more likely to
make you think, rather than act, which is exactly
what you want information to make you do.
2. Who You Talk to About Your Investments
New York Times columnist Carl Richards has a great
saying. A financial advisor, Richards says, is someone who puts a gap between you and stupid.
Even brilliant investors are tempted to fall for
biases and do dumb things with their money. An
advisors job is to look you in the eye, shake his head,
and walk you back from the ledge.
One of the leading causes of biased financial
decisions is confirmation bias. Its the tendency
for investors to seek out advice from people who
already agree with their views.
I attend a lot of financial conferences, many of
which are theme-based macro conferences, gold
conferences, dividend conferences, and so on.
What astounds me at these conferences is how
closed off they are to differing opinions. If you
attend a gold conference and say anything negative
about gold, you will be treated as an ignorant

The Motley Fool January

Battle Your Brain: How to Become a Less-Biased Investor


outsider and avoided. People think they attend
conferences to learn something new, but Ive
learned thats not really the case. They attend to
have their views confirmed by other people. It is
pure confirmation bias. And its dangerous.
Kathryn Schulz, author of the book Being Wrong:
Adventures in the Margin of Error, once explained:
The first thing we usually do when someone disagrees with us is we just assume theyre ignorant.
They dont have access to the same information that
we do, and when we generously share that information with them, theyre going to see the light and
come on over to our team. When that doesnt work,
then we move on to a second assumption, which is
that theyre idiots. They have all the right pieces of
the puzzle, and they are too moronic to put them
together correctly. And when that doesnt work, we
move on to a third assumption: they know the truth,
and they are deliberately distorting it for their own
malevolent purposes. So this is a catastrophe.
If you dont surround yourself with people who
disagree with your views, youll never realize that
you can be just as biased and wrong as everyone else. And youll keep making the same mistakes.
Part of The Motley Fools investing ethos is a
culture of encouraged debate. We not only accept
dissent when making stock picks but encourage it.
Junior analysts can and do tell their bosses why
theyre wrong. This is how we fight confirmation
bias.
But theres something we cant do for you, our
members: prevent you from buying more stocks
when the market is bubbly and selling out when it
crashes.
One of Kahnemans pieces of advice to avoid
biases is to have an advisor who is in a different
emotional state than you are. This is how individual
investors can avoid confirmation bias.
You should have a trusted person in your life
a friend, a relative, a co-worker who you run
financial decisions by.
This person should know you well. They should
know your goals and your flaws. But they cant be
emotionally attached to your financial decisions.
Their goal is to provide a trusted, yet unbiased,

opinion of your decisions. They put a gap between


you and stupid.
For the past seven years, I have shared my
personal financial plan with fellow Fool Matt
Koppenheffer. I trust Matt, but he thinks differently
than I do. Hes not nearly as emotional as I am in
some areas, sees risks that I dont, and offers a point
of view that I could never come up with on my own. It
is a perfect arrangement for avoiding biases, because
while I trust Matt, I dont agree with everything he
says and he doesnt always agree with me. That is
exactly what you want. Rather than confirm my
views, Matt makes me think and puts a gap between
me and stupid. Every investor should have someone
like this.
3. How You Keep Yourself Accountable to Your Goals
One of the most important lessons Ive learned
about investment biases is that people are terrible at
predicting their future emotions.
Every investor I know says theyll be greedy
when others are fearful. They never assume that
they themselves will be the fearful ones. But someone has to be, by definition.
No investor wants to think theyll panic and sell
if stocks fall 20%. Theyre more likely to say that a
20% decline would be a buying opportunity. This is
the right attitude, but the reason there will be a 20%
crash is specifically because some investors choose
panic selling over opportunistic buying.
My experience is that most investors who say
theyll be greedy when others are fearful soon realize
that they are the others. It has to be this way: When
everyone thinks theyre a contrarian, at least
half will be wrong.
When investors are bad at predicting their
emotions, sticking to their financial goals becomes
difficult. I can say I plan on investing $500 a month
each month for the next 30 years. Or I can assume
that I wont sell when the next market crash comes.
But those goals rely on the assumption that I can
behave the way Id like to in the future. And thats a
dicey assumption to make.
I have found that the best way to get a realistic

The Motley Fool January

Battle Your Brain: How to Become a Less-Biased Investor


picture of my future emotions is to document my
past emotions. You can do this by keeping an investing journal.
Every investor, no matter how active or passive,
should have an investing journal. It doesnt have
to be elaborate. Just document how youre feeling
when you make investment decisions.
If you keep a detailed journal of your feelings and
emotions when making investment decisions and
review it over time, I think you will notice that how
you expected to feel when the market falls, or surges,
is far different from how you actually feel.
This is easy for me, because Im an investment
writer. All of my thoughts and feelings are documented on Fool.com.
Id like to think of myself as a contrarian investor. Id
like to think a market crash is a wonderful thing to
take advantage of. I want to be Mohnish Pabrai.
But when I look back at articles I wrote in 2008

and 2009, as the market was crashing, I have to


admit: I was more scared and pessimistic than I
thought. If Im honest, they show that I have a lower
risk tolerance than I think I do.
And I never would have known this unless these
past feelings were in writing.
Admitting this is part of the reason I choose to
hold quite a bit of cash in my portfolio. I dont want
to pretend that I have a high risk tolerance that,
objectively, is probably a fantasy. Right now, with
the market near an all-time high, that would be
easy to do. To prevent bias, I want to look at my past
behavior and realize that its probably a good indication of what my future behavior will be.
I would recommend every investor write down
their feelings. A few sentences a few times per
year. Keep this journal active for years, throughout
different market conditions, and be honest with
yourself about what you find. It could be the best
tool you have to avoid future regret.

The Motley Fool January