Why permabears seem right even when they're wrong 🐻

For many, it's the same financial outcome regardless of whether the bears are right or wrong 🤑

An AI-generated image of bears and money.

Why are the permabears (i.e., financial market pundits who spend most of their time being bearish) embraced by so many even though they spend most of their time being wrong?

It’s a complicated question we in the financial blogosphere have been wrestling with for years. And many of my peers have advanced some good answers. More here and here.

I’ve been thinking about this question more and more in recent weeks. And in my reflection, I’ve noticed a pattern in how retail investors rationalize their financial performance after embracing an incorrect bearish view. It goes something like this: “Well, at least I didn’t lose money.“

Let me explain what I think is happening here.

There’s a big difference between shorting the market and taking risk off 🤔

If you’re bullish, you make money when stocks go up (i.e., you’re long the market). And if you’re bearish, you make money when stocks go down (i.e., you’re short the market). Right?

While this framework makes sense in the theoretical and professional worlds of finance, it’s actually not how all investors act with their finances.

In my conversations over the years with retail investors — many of whom are novices (not that there’s anything wrong with that) — most don’t swap their long positions for short positions when they turn bearish. Rather, they tend to embrace more of a risk-on versus risk-off approach.

What’s the difference?

If you’re long the market or you’re taking on risk, then you are financially exposed to price fluctuations. When prices go up, you make money. When prices go down, you lose money.

If you’re short the market, then you are still financially exposed to price fluctuations, but in an inverse way. When prices go up, you lose money. When prices go down, you make money.

BUT if you’re taking risk off, it’s a completely different story. When you take risk off (e.g., move your money out of stocks and into something more stable like cash), then you are reducing your exposure to price fluctuations. In the extreme scenario where you are fully risk off, you don’t make or lose money regardless of whether prices go up or down.

I don’t have a great stat on this. All I know is I can recall many anecdotes where investors acted on a bearish perspective by taking risk off, not by ramping up short positions.

This matters because ultimately, nobody really cares if a bull’s or bear’s thesis is right. What they care about is that they realize the intended financial outcome.

If you’re bearish and you decide to take risk off, the financial outcome you seek is to not lose money.

And when you take risk off for this reason, the financial outcome of not losing money will happen regardless of whether the bearish thesis was right or wrong — and regardless of whether prices went up or down.

In this sense, permabears will always be right for risk-off-type investors, because they’ll never lose money.

‘Not losing money’ can actually be very costly 🧐

Everyone hates losing money.

So, being able to say, “Well, at least I didn’t lose any money,” feels great when the market falls, and feels not too terrible when the market goes up.

But when it comes to big decisions about money, we should also be thinking about financial goals.

For many people, the stock market is where you seek to accumulate long-term wealth. Maybe it’s how you save for your retirement or your kids’ college tuition. Maybe it’s how you plan on paying for that dream vacation home in 20 years.

In order to achieve most of these major financial goals, you have to be in the market willing to stomach short-term bouts of volatility. While it’s great to not lose money when the market is down, it can be incredibly costly to be out of the market when prices are going up. With the market being up 80% of the time, time in the market matters. And to be clear, the opportunity cost of missing out on returns is a cost. More here and here.

If you’re a long-term investor aiming to build wealth in the stock market, it’s a mistake to take comfort in knowing you didn’t lose money when the market was going up. Maybe denial helps you cope with the mistake of buying into a permabear’s thesis at the wrong time. But it won’t help you repair what may be permanent damage done to your long-term potential returns.

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