Your assumptions can make you feel miserable. Your assumptions can also make you feel peaceful. The difference is how well your assumptions match the reality.
Here’s an example. One of our biases as humans is loss aversion. $100 lost hurts more than $100 won makes us happy. That bias is ingrained in our psychology over billions of years of evolution. Like all the other biases and logical fallacies, the best way to handle it is to become aware of it and to consciously work on it to let it go.
Loss aversion is an assumption that is guaranteed to make us miserable over time. It is also guaranteed to make us lose money over time. Loss aversion makes us avoid investing because of the inherent risk. However, we know that savings in fiat currency such as USD and euro will lose some of their value over time. Loss aversion actually makes us lose a portion of our savings.
Another assumption that makes us feel miserable is that a good investor must know which asset will appreciate the most, when, and how much. When we make that assumption we try to find that asset, we try to time the market, and we start trading. As we know, human psychology is our worst enemy when trading and as a result, we lose money.
More Realistic Assumptions
How can we replace the loss aversion bias and the perfect trader assumption?
We can do that by replacing them with other assumptions.
- Savings in fiat currency such as USD and euro will lose some of their value over time.
- No one can find the asset that will appreciate the most, when, and how much.
When you make the two assumptions above, your investment decisions become trivial. All you have to do is to build a strategy on top of them.
- Invest savings in cash to a diversified portfolio, such as S&P 500 index funds, over time using dollar cost averaging.
- Don’t sell unless you need the money.
By investing the cash, the savings are prevented from losing their value over time due to inflation. That satisfies the first assumption. Holding a diversified portfolio satisfies the second assumption. We don’t try to find the asset that would appreciate the most. Dollar cost averaging also satisfies the second assumption, because we don’t try to time the market.
By not selling unless we need the money, we avoid trading, because the more we trade, the more we lose. S&P500 index funds are already diversified, but a portfolio can be further diversified using other assets.
Like all realistic scenarios, the scenario above also has its risks. The main risk is the market crashing after you have invested the maximum amount. This is a realistic scenario. But the history has shown us that the markets have recovered after crashes and reached new highs. That’s why we have the last part, don’t sell unless you need money.
If you accept the fact that losing money is inherent in having savings in every scenario, loss aversion loses its meaning, because there is always a risk of losing money, no matter what you do. You can’t do anything about it. It’s outside of your control. Once you accept that fact, you stop feeling miserable about it and you have peace of mind.
Do you feel miserable in a certain area of your life?
Whenever you feel bad in a certain area of your life, ask yourself the following question.
- Which assumption do I make that makes me feel miserable?
- Does this assumption match the reality?
- Which assumption can I adopt that matches the reality more?
Once you accept the reality completely, align your assumptions with it, and act on those assumptions, you will stop feeling miserable, and have peace of mind.
This post is for information purposes only and not intended to be investment advice.