Do you remember Bitcoin? Probably, but do you spend as much time thinking about it as you did earlier this year? I’m willing to bet not, and if that’s the case maybe now is a good time to reflect on the lessons learned. Maybe the biggest value Bitcoin has provided to date is the lessons it taught us in behavioral finance.
Remember that neighbor who would recite for you daily the price trajectory of Bitcoin? Have you heard from him on the subject lately?
This doesn’t mean that Bitcoin is not destined for a big increase in the future. Bitcoin’s market dominance is now back over 50% of the cryptocurrency market, which has resulted in even bigger declines in the alternative cryptocurrencies. If you were excited about its prospects when it was priced at $17,000, you likely should be much more so now at $7,000.
However, given the recent experience, it’s not unlikely that Bitcoin suddenly feels inappropriate for your risk tolerance. If your appetite drops off significantly just because an investment pulls back, then chances are your initial decision making may have been influenced by some very common behavior biases. To name a few:
Trend Chasing – In December and January when Bitcoin was topping out, maybe that also happened to coincide perfectly with when you were developing your view on it as an asset. If that was your reason for being a purchaser then, you likely made a well-disciplined investment decision. However, if your decision was based solely on the expectation that it would continue its recent performance, you were likely a victim to trend following. There’s a reason why the first disclaimer on any investment document you receive is “Past performance is not a guarantee of future results.”
A great lead into this behavior can be a Hindsight Bias, believing that somehow the prior results were perfectly predictable. You think you should have anticipated these results at the time and participated in the stellar performance up to this point. You remember reading the word “Bitcoin” in an article in 2015, but never bought any. But certainly you won’t be that foolish again, right?
Regret Aversion – Maybe you weren’t concerned with achieving the performance, but rather you were afraid of being the only one who didn’t participate. It seemed like everyone you knew was buying Bitcoins, and you couldn’t bear to be the only one who didn’t. You couldn’t watch the news at the gym or make small talk in the elevator without touching on the subject.
Just imagine how awful the social interactions would be if you were left out. We all know there are plenty of reasons for social events to be awkward to begin with, but your investment decisions should never be one of them.
Sunk Cost Fallacy – Do you know people that still hold their bitcoins? The key question is do they still do this because of their continued bullish outlook, or because they already have a big loss in the position. If it’s the latter, this behavior is not one that leads to making good investment decisions going forward. Smart investing involves having a steadfast procedure for decision making and regularly revisiting it.
Virtually no long-term investor is going to make it a lifetime without their own “Bitcoin Experience.” Some will learn that such investments are well outside their risk tolerance. Others may even learn that they will have a profitable future by weathering highly volatile assets. But what is most important is that all investors are also learners. There is almost nothing more detrimental to your overall financial well-being that consistently succumbing to behavioral traps.