Investing, fast and slow

It seems to be a natural law that negatives happen fast while positives happen slowly and steadily. No unhealthy person gets healthy suddenly, but a lot of people lose good health suddenly. No one gets rich in a day, but many become poor overnight. Think of it this way. Can there be an event that causes the world's economic output to drop by some catastrophic amount, say 10 per cent, in just a year? Yes, definitely. Covid could have been such an event. However, can the opposite happen? Could something happen that could cause an equivalent boost in a year? No, absolutely not. The chances of such a miracle are as close to zero as possible.

Also, this asymmetry is scale-dependent. Can an individual become wildly rich very quickly? Yes, it happens every day to some people around the world. Can the equivalent happen to a small business? Large business? Entire sector? A country? The whole world? As you go up in scale, the variability reduces. However, the size and speed of the possible negative shock are always much larger. Apart from trivial examples like winning a lottery, the negative surprise can be much more powerful and sudden on every scale than the positive surprise.

The equity markets are a great example of this phenomenon. Disasters - big crashes - in the equity markets stick to the mind, while gains - no matter how huge - are delivered over months or years. We remember the code red phases but get used to the steadily rising phases. Growth is eventually taken for granted while crashes stick in the mind.

This tendency to remember the negative events more vividly than the positive ones can significantly impact investor behaviour. During market downturns, fear and panic often lead to hasty decisions, such as quitting prematurely. On the other hand, the gradual nature of positive growth may lead to complacency, causing investors to overlook the importance of making an effort to understand what is actually going on. Understanding this psychological bias is crucial.

Disasters in equity investments - like the one in 2008-09 - draw far more attention and stick to the mind far more than long and gentle periods of gains. At the pre-crisis peak 15-16 years ago, the BSE Sensex was just under 21,000. By March 2009, it touched a low of 8,325. It was the biggest disaster in investing that any equity investor could remember. The BSE Sensex is now (as I write this) at 74,000+ points (about 9x that peak), and investors have been steadily making money, with a few hiccups here and there, for years now. And yet, these gains have happened steadily and with some interruptions, so they don't stick in the mind as an event.

What's more, our mental model of how to invest has changed because the source of success in equity investing has changed over the years. Once upon a time, you needed some kind of an information advantage, some access to people or institutions that were not commonly available. Today, that's emphatically not the case. All information and analytical techniques are available to everyone. For the most part, everything is free. Investors are limited only by their own intelligence, knowledge and the time that they can dedicate to investing. Moreover, by using equity mutual funds, the amount of attention required and the quantum of risk becomes even lower, while the likelihood of steady gains becomes that much higher.

Considering this history, can you predict what this list might look like in 20 years? Or even 10? Yet, for an investor, this should not matter. The actual identity of the companies is merely information, which inevitably changes. As a straightforward guide to investing, today's information will be as irrelevant a decade from now as data from a decade ago is today. However, what remains constant are the fundamental principles of business and investing—the rules by which companies achieve and maintain their success.

Also read: One day vs many years