Statutory Warning: Market Crash Predictions are Injurious to Your Portfolio

This article was originally published in LiveMint. Click here to read it.

A young Captain fell into a well by mistake. His soldiers who saw this immediately came to his rescue. They threw a rope into the well to take him out. But there was a small problem. As soon as the Captain would come up to the top of the well, all of them left the rope and saluted him. The Captain again fell into the well. The same routine repeated for 6 times. Finally the soldiers gave up.

They went to their Major for help. The Major rushed to the spot, threw the rope and started to pull the Captain out. As soon as the Captain reached the top of the well, he spotted the Major. He immediately left the rope and saluted the Major. Once again, he fell into the well.

This funny story is a good reminder of how we sometimes follow authority figures blindly without understanding the context. Behavioural Science even has a fancy name for this – Authority Bias.

Authority Bias 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 doctors, dentists, lawyers, etc. It would be exhausting if we had to do 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 majority of situations. The real issue occurs when influence from authority gradually becomes an automatic response. There are certain situations where this can backfire bigtime. 

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 the authority in that subject. This means there is a good chance that you may sell out or reduce your equity exposure fearing a possible crash as the expert has predicted.  

But here is where you need to take a pause and ask a simple question – “Can you name 5 investment experts who have consistently exited equities before a market crash and entered back at the bottom”

If you are struggling for an answer, no worries. You already have your answer.

Let us hear what the legendary John Bogle has 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 don’t 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 fell for the authority bias!

No doubt, respect for authority is a foundation of civilization 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 doesn’t necessarily have to be true. 

So the next time you see someone on TV with a scary “Market is going to crash” prediction – it’s 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!