SEVEN LOGICAL THOUGHTS THAT CAN RUIN YOUR FINANCIAL LIFE
This article also appears on Forbes
The logical mind that has created most of the advancement we have seen as humankind is a detriment in the financial markets. While logic allows you to be a functional human being, having a firm grasp of what is illogical will be what allows you to profit consistently.
What do I mean? Let’s start with a simple premise. In order to survive in the financial markets over the long run, you must view the market as a thief. It wants what you have and uses manipulation of emotion to get it. The primary emotions are that of fear and greed. It is coded in your DNA to become greedy when all is going in your favor. Similarly, when you are dying a slow death at the hands of a blistering foul wind, you are programmed to flee the situation.
The market routinely manipulates the emotions of fear and greed, causing you to exit positions when the probability of achieving outstanding gains over the next 12, 18 or 24 months are at their best. Conversely, you are manipulated into buying situations that are inherently dangerous and have a high probability of working against you during periods of extraordinary comfort and joy.
Routinely, issues of seemingly logical importance make their way into your psyche during the most crucial times. As an example, during the depths of financial Armageddon in 2008, it was seen as perfectly logical that the financial system as we know could be finished. The phrase “end of capitalism” was being thrown around like we were talking about the end of a baseball game. Logical thinking told investors that safety was of the utmost importance. Anything tied to capitalism was to be abandoned in the favor of cash. Preferably cash in a foreign currency of a third world country that wasn’t tied to capitalism.
It was thought of as illogical to recommend heavy allocation into equities. The thought of the Nasdaq being near ten year highs just three years later would have been seen as illogical thinking. It became logical to think that the financial markets were destined for a sideways range at best, with a continued bear market and deep depression being the logical outcome. The logical mind failed investors, as it always does. The illogical thinkers came out ahead, as they usually do.
The logical mind can also betray investors in individual stocks.
The recent action in companies like Netflix (NFLX) and LinkedIn (LNKD) deceive the logical mind. In fact, the fuel for their fire is based on a logical dissection of a situation that can’t be logically understood. I have been very bullish about the prospects of NFLX for all of 2011. I have also been bullish on LNKD for the entirety of its public market existence.
If I were to attempt to logically dissect either of these companies, I would not only stay as a far away from them as possible, I would likely be looking to short them to my own detriment. Logical interpretation of these stocks fails. The numbers fails to justify the stock price. Just as the numbers during the bottom of 2008 failed to justify the historic rally that has taken place over the past three years. Just as logical thinkers failed to steer you clear of buying a home in 2005, and instead told you to buy a boat using equity from your home. Just as logical thinking said it was perfectly fine to be invested in Pets.com and Garden.com in 1999 and 2000.
It is easy to look at these events now and tell yourself that it was the illogical mind at work during these periods of euphoria and failed vision. In 2005, I was sitting at a table in the middle of Silicon Valley talking to a group of wealthy real estate investors. I brought up the question of real estate possibly being overvalued and not being able to sustain the gains of the past several years. I was looked at as if I had just grown floppy ears and a tail. It was completely illogical to think of real estate–especially California real estate–ever going down. “Too many people want to live in California,” I was told. “The demand will always be there to support the price.” This was the logical argument of the time. Logic failed once again.
What’s an investor to do? Realize that your logical mind is being stalked by the financial market. Come to terms with the fact that what you perceive as being an illogical trend taking place in the markets has roots far deeper than you suspect. Be suspicious of what you deem completely logical.
Where is the logical mind focused today?
1. The equity markets should be avoided. Logical thinkers feel that given all of the negative economic events we have experienced over the past 11 years and the bleak prospects for a sustainable future recovery, allocation to stocks is dangerous at best.
2. The housing market will come back eventually. Logical thinkers feel that real estate will continue to be a long-term outperformer.
3. Apple (AAPL) has the perfect mix of products, service, innovation and genius to continue until it is above $1,000 per share. AAPL is full of logically oriented investors. Doubting AAPL is thought of as highly illogical.
4. Oil prices can’t go above $150 per barrel. Logical thinkers feel that gasoline prices above $5.00 per gallon will destroy the U.S. economy. That number used to be above $4.00 per gallon. It hasn’t destroyed the economy so logical thinkers simply raised the number to $5.
5. The Dow and S&P have been in the same place for more than 10 years, therefore a sideways trend is likely to persist. Logical thinking relies heavily on past events to close the mind to future events that defy the established trend. Dow 6,000 is much more likely than Dow 20,000 according to logic.
6. A company like Netflix shouldn’t be near $300 per share. It has too much competition. The business model is weak. Logical thinkers have been doubting NFLX for the last 200 points.
7. A company like LinkedIn shouldn’t have debuted above $50 per share. Let alone be sitting at its current price of $100 per share. Logical thinkers believe that their inability to comprehend such a steep premium for LNKD translates into an imminent, sustained drop in the share price.
The desire to deceive and surprise investors is tattooed across the markets forehead. For that reason you must allow your logical mind to remain what guides you through everyday life. However, when you enter the financial market arena, it is imperative to shut it off and allow your mind the creativity to imagine illogical pricing scenarios that only a person with floppy ears and a tail could dream of.
