A 2018 Harvard study asked non-colour-blind participants a simple question: Can you identify blue dots on a screen containing blue and purple ones?
The answer, perhaps unsurprisingly, was “yes”. For the first 200 trials at least.
From that point, researchers began to replace the blue dots with purple ones until only purple dots remained. Participants, though, continued to report a roughly 50/50 split. They had effectively altered their perception of “blue” to match their preconceived ideas.
This is now known as the “Blue Dot Effect” and suggests, to some scientists at least, that human beings are predisposed to pessimism.
But is this really the case? How exactly does the blue dot experiment “prove” it? And what implications could the phenomenon have for your investments?
Keep reading to find out.
The blue dot experiment suggests pessimism is an evolutionary imperative that persists today
Harvard scientists followed up the blue dot experiment with similar tests.
Coloured dots were replaced by threatening and non-threatening faces, and then ethical and non-ethical research proposals. Again, participants simply shifted their view of “threatening” and “ethical” to match their assumptions.
Because the 50/50 split was maintained for a sustained period at the start of each experiment, researchers concluded that human beings continue to believe a truth, even after it ceases to be true.
While it might feel like a jump, this led to the conclusion that human beings are evolutionarily predisposed to pessimism.
Our ancestors fought wars with neighbouring tribes, succumbed to diseases they didn’t understand, and were at the mercy of natural disasters that they couldn’t hope to predict. A constant state of alert – the fight or flight response – was a necessity. With the next threat always around the corner, the species became naturally pessimistic.
Despite thousands of years of progress, we’re still fighting, and still on a constant search for negatives. Doomscrolling bad news and moaning about politicians isn’t a modern problem, then. It might just be how we’re hardwired.
This can create problems in everyday life, not least in your finances.
3 ways pessimism could harm your investments and what to do about it
1. Subconscious biases
One way in which in-built pessimism could affect your investments is through emotional and cognitive biases. One such bias is known as “loss aversion”.
You are programmed to feel the pain of a financial loss more acutely than the joy of a corresponding gain. Losses hurt, whereas gains are quickly forgotten. (You might even tell yourself the gain was inevitable, due to over-confidence bias.)
Loss aversion can affect your investment choices by making you risk averse, actively avoiding losses at the expense of possible gains. Balancing risk and reward is a crucial part of investing, though, so take a step back and try to remain objective.
With decades of combined market experience, Globe IFA can help to ensure your portfolio always aligns with your risk profile and your decisions are in service to your long-term goals.
2. Opportunity cost
Money held in cash might not make spectacular gains but at least it’s safe. Investing, on the other hand, carries risk and you could lose all your money.
At least, that’s what the pessimist in you would say.
In reality, the trend of investment markets is upward, your portfolio is diversified to spread risk, and a long-term time frame gives your money the chance to ride out periods of short-term volatility.
The biggest risk for your future financial stability, then, could be not taking enough risk. This is the opportunity cost of pessimism.
While markets provide the opportunity for significant returns, money held in a high-street bank could effectively lose real-terms value, especially during periods of high inflation. Ultimately, the opportunity cost of missed investment returns could delay the realisation of your goals or damage your future lifestyle.
3. Emotional decision-making
When markets crash, it’s natural to worry. The pessimist in you might decide to cash out, but emotional decision-making can be extremely damaging.
Schroders recently looked at the long-term cost of cashing out when markets fall. Among other historic market drops, the report looked at the Great Depression of 1929.
It found that investors who moved to cash after the first 25% drop waited until 1963 to break even again. Those who stayed invested broke even in 1945. That’s eight years earlier.
It’s worth remembering that the stock market dropped by more than 80% during this crash.
Similarly, an investor who moved to cash after the first 25% of losses during the 2008 financial crisis would not yet have broken even. Those who remained calm, and invested, broke even less than five years later.
The best way to see long-term investment returns is to stay optimistic – and invested.
Get in touch
Globe IFA’s expert financial advisors can help you combat pessimism and subconscious biases to better manage your long-term financial plans. Email hello@globeifa.co.uk or call us on 020 8891 0711 to discuss how.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
