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If you are feeling pretty glum about the world right now, you probably know why.
Between rising authoritarianism, surging energy prices, spiralling geopolitical conflict and willful disregard for climate change, there is plenty of bad news to challenge our natural optimism.
Does a dim view of the future affect our investing decisions?
Optimism looks like a requirement for successful investing. It drives us to take some risks with our money in the hope of a handsome payout down the road.
Many stocks require economic growth, along with freewheeling consumer spending, to generate profits and dividends – all of which rests on a sunny outlook. Without a belief in better days ahead, there may be a temptation to think short-term and live for today.
Natural optimists would seem to have all the advantages if their disposition translates to long-term investing, given that the stock market has performed well over time and recovered from nerve-rattling downturns. For what it’s worth, optimists tend to live longer, too.
But optimism has its drawbacks.
It can lead to excessive risk-taking if you’re constantly assuring yourself that everything will be okay. It can also obscure the bleak reality that some struggling companies may face, which can be financially disastrous if you’re chasing a flailing stock.
How many optimists were caught in the Nortel Networks debacle, the dot-com bubble or the recent meme-stock phenomenon? How many are currently jumping into bitcoin or chasing the artificial intelligence theme?
“The takeaway is simple – confidence is valuable, but only when it remains anchored to reality. In investing, optimism can be a strength right up until it becomes a source of instability,” Goutham Gopalakrishna, assistant professor of finance at the Rotman School of Management at University of Toronto, said in an e-mail exchange this week.
I reached out to Mr. Gopalakrishna because he co-authored a 2024 paper, Beliefs and the Net Worth Trap, with Seung Joo Lee at the University of Oxford and Theofanis Papamichalis at University of Cambridge (he is now at Yale University), which addressed the topic of optimism.
The researchers found that optimists performed well when the economy and markets co-operated. They were rewarded for their risk-taking nature.
But bad news could be disastrous if optimists invested into a downturn and refused to recognize a shifting reality for stocks.
“A moderate degree of optimism can help investors build their wealth by earning the premium associated with that risk,” Mr. Gopalakrishna said.
But it can backfire: “Too much optimism can be damaging in the sense that investors can fall into a ‘net-worth trap’, where their wealth gets drained to the point that they cannot recover their investment,” he said.
So if you’re feeling a bit glum about the future, maybe that’s okay. A little pessimism is perhaps what you need to stay grounded and aware of the downside risks, which is key to successful investing.
Is your outlook on world affairs influencing your investment decisions? Let me know at dberman@globeandmail.com.
And here’s a pitch, regardless of whether you’re an optimist or pessimist: Use virtual cash in our free stock-picking challenge, which awards cash prizes for delivering a winning portfolio of stocks.
But don’t sit on your hands too long. The Globe and Mail Trade Off starts soon. More details here.
Chart of the day
New products that caught my eye
I tend to wander through the computer landscape, depending on my needs and budget. That’s why the Apple MacBook Neo has my attention: a budget laptop that will probably serve my needs and save me money on things I don’t. Here’s a good comparison between the Neo and the more expensive MacBook Air, and here’s an early thumbs up review.
We want to hear from you
There was an interesting tidbit in this month’s Toronto housing report: new listings are actually dropping significantly compared to last year. One realtor believes it’s because condo investors have more options today, like increasing amortization or using alternative lenders. They’re using those options to wait out the market.
We want to hear from investors who own condos. Are you doing everything you can to hold onto your condo until there’s a better time to sell? Have you taken advantage of being able to increase your amortization to do so? Are you using alternative lenders to qualify?
Reach out to sfarooqui@globeandmail.com if you’d like to share your experience for an upcoming story.
