Lions and Tigers and Bears, Oh My!

(Zen Buddha Silence by Marilyn Barbone)

(Image:  Zen Buddha Silence by Marilyn Barbone.)

January 29, 2017

As humans, the ancient part of our brains – including the amygdala – alerts us subconsciously if there is the slightest sight or sound of something that could be dangerous (e.g., a lion, a tiger, or a bear).  Such an alert happens so fast that our body prepares for fight or flight long before we are even conscious of the potential threat.

Unfortunately, plummeting stock prices very often trigger the same fear response in our ancient brains.  This often causes us to make bad decisions.



One key to investing is to learn to minimize the number of mistakes we make.  A great way to minimize our mistakes is to follow an automatic system for investment decisions.

For many investors, the best automatic approach is simply to buy and hold low-cost broad market index funds.  These investors, if they stick with it over several decades, will do better than 90-95% of all investors.  And this winning strategy requires very little time to implement.

For investors who want a proven, relatively low-risk way to beat the market, a quantitative value investment approach is a good option.  One of the best research papers on why a value investing strategy beats the market over time, without taking more risk, is “Contrarian Investment, Extrapolation, and Risk,” by Josef Lakonishok, Andrei Schleifer, and Robert Vishny.  Link:

Lakonishok, Schleifer, and Vishny were so convinced by the evidence that they started LSV Asset Management, which today has over $87 billion in assets under management.  LSV uses a quantitative value investment approach which automatically selects a portfolio of stocks based on the factors supported by their research, including low price to earnings and low price to cash flow.  See:



The truth is that most of us do not know ourselves very well at all.  But recent advances in psychology and neuroscience have made it possible for us to know ourselves much better.  Slowly but surely, studying our own mistakes and studying the best psychology can help us to make better decisions over time.

When it comes to decision making under uncertainty – and this includes investing – there are many great books that are absolute must-reads, including the following:

  • Daniel Kahneman, Thinking, Fast and Slow (Farrar, Straus and Giroux, 2013, 2011)
  • Charles T. Munger, Poor Charlie’s Almanack, edited by Peter Kaufman (Walsworth Publishing Company, Expanded Third Edition, 2005)

There are many more great authors on decision making under uncertainty, including Michael Mauboussin, James Montier, and Richard Thaler, to name just a few.  But in the interest of brevity, this blog post focuses on a chapter from James Montier’s Value Investing (Wiley, 2009), Chapter 13: The Psychology of Bear Markets.



Montier writes that Abraham Lincoln relayed the following story:

Solomon once charged his wise men to invent him a sentence, to be ever in view, which should be true and appropriate in all times and situations.  They presented him with the words ‘And this, too, shall pass away’.  How much it expresses!  How chastening in the hour of pride.  How consoling in the depths of affliction…  (page 123)

Unfortunately, says Montier, when it comes to investing, we are often overwhelmed by fear or greed instead of training ourselves to slow down and to use careful logical analysis.  We have two mental systems, one that is automatic and intuitive, and the other that is capable of deliberate, rational thinking.  The automatic system is the more ancient system, and we share it with many other animals.

The problem is that paper stock losses cause fear.  The fear response is very powerful and largely unconscious initially, originating in the amygdala.  It prepares the body for fight or flight even before the conscious mind has had time to analyze the situation.

Most of the time in our evolutionary history, a fear response to movement in the grass was appropriate for maximizing the chances of survival.  A rapid response to a potential threat had a low cost in the case of a false positive, notes Montier.  But a false negative – not reacting to the movement in the grass, but having it turn out to be a lion – was potentially fatal.

Yet a fear response to paper stock losses is almost always harmful for long-term investors.  When stocks drop a lot (10-40%), many long-term investors with time horizons of at least ten or twenty years are overwhelmed by fear and sell when they should be buying.  For instance, many long-term investors were overwhelmed by fear (and loss aversion) in the bear market of late 2008 to early 2009.  Long-term investors who sold missed out on a more than 200% recovery (from the lows) for the S&P 500 Index.

Conversely, long-term investors who have mastered their fears – by having an automatic investment system, or by having trained their own responses, or both – bought in late 2008 and early 2009 and are much better off as a result.



James Montier describes a study by Shiv et al. (2005).  It is a game at the start of which each player receives $20.  The game has 20 rounds.  Each round, the player can decide to bet $1 or not.  Then a fair coin is flipped.  If it comes up heads, the player who bet $1 gets $2.50 back.  If it comes up tails, the player who bet $1 loses the $1.

It is optimal for the player to bet $1 in each of the 20 rounds because the game has a clear positive expected value – the wins will outweigh the losses on average.  Also, the decision to bet $1 each round should not depend upon whether one won or lost in the previous round.  Each flip is independent of the previous flip.

What actually happened, however, was that people invested less than 40% of the time after suffering a loss.  Furthermore, the longer the game continued, the lower the percentage of players who decided to bet.

As losses add up, people become more and more fearful, and less and less willing to invest even though the best time to invest is during a period of extended losses (like late 2008 and early 2009).  Montier writes:

The parallels with bear markets are (I hope) obvious.  The evidence above suggests that it is outright fear that drives people to ignore bargains when they are available in the market, if they have previously suffered a loss.  The longer they find themselves in this position the worse their decision making appears to become.  (page 125)



Montier observes:

Investors should consider trying to adopt the Buddhist approach to time.  That is to say, the past is gone and can’t be changed, the future is unknown, and so we must focus on the present.  The decision to invest or not should be a function of the current situation (from my perspective the degree of value on offer) not governed by our prior experiences (or indeed our future hopes).  However, this blank slate is mentally very hard to achieve.  Our brains seem to be wired to focus on the short term and to fear loss in an extreme fashion.  These mental hurdles are barriers to sensible investment decision making in a bear market.  (page 127)

A bear market can occur at virtually any time.  At some point in the next five or so years – possibly even this year – there will likely be a bear market in which stocks drop at least 20-25% (and possibly much more).  It’s essential for all investors that we have an automatic, checklist-like approach to plummeting stock prices in order to maximize rational decisions and minimize irrational decisions.  It’s also essential for many of us as investors that we develop a keen understanding of our own emotional responses to plummeting stock prices.

Knowing in detail how we will feel in the face of plummeting stock prices, and having a rational set of responses (ideally automatic and preprogrammed), is one of the keys to successful long-term investing.



One important rule for long-term investors is to check stock prices as infrequently as humanly possible.  A flashing, plummeting stock price is a subliminal message that very often will activate our subconscious fear response – SELL!  SELL!

For a long-term index fund investor, it is possible to check stock prices only a few times per year or less.  Similarly for a long-term value investor, one should check prices as infrequently as possible.

If we are tempted to check stock prices, especially when prices are plummeting, there are simple techniques we can use to avoid the temptation.  Obviously being deeply engaged in a work project is ideal.  Or we can read, watch a movie, or even go to the beach.  Many long-term value investors recommend going to the beach – ideally with a stack of great books or annual reports – instead of checking or worrying about cratering prices.

Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.  – Warren Buffett

Invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price.  – Ben Graham

When we own stocks, we are part owners of the underlying businesses.  So if we are happy with the businesses we own, we should never waste time worrying about or checking falling prices.  If we understand and believe in the underlying business, then a dropping stock price is a wonderful opportunity to increase our ownership of the business.  A good rule is to add to our position for each 10% or 15% drop in price.

If we own a low-cost S&P 500 index fund, then we are part owners of five hundred American businesses.  As long as we believe the U.S. economy will do well over the coming decades – and it will do well, even if grows a bit more slowly than in the past – then when the index drops a great deal, it’s a wonderful opportunity to add to our position as a part owner of American businesses.

As long as we have uncorrelated or negatively correlated positions in our overall portfolio – such as cash, cash equivalents, or gold – it is simple to implement an automatic rebalancing rule.  For instance, during or after a period of falling stock prices, we would use some cash (or gold) to increase our ownership of the businesses we like best.  Ideally, this rebalancing is preprogrammed to occur at the end of a specified time period (e.g., quarter or year).

Just for fun, a 30-second link from the Wizard of Oz:



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

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