The Experience Fallacy

It’s been forever and a day since the Fed last raised rates so I keep seeing headlines or hear people say some variation of the following:

There’s a huge group of young traders and investors who have NEVER lived through a rising rate environment.

There are other examples people use as well — a highly inflationary environment, a bear market, etc. To some degree I can see where these people are coming from. One of my all-time favorite Fred Schwed quotes talks about the importance of experience in the markets (or life in general):

Like all of life’s rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. You cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be adequately explained to a virgin by words or pictures.

Having said that, I think people play the experience card far too often.

Do you know who controls the majority of the wealth in this country? Older and more experienced people. By definition, that means the majority of the losses will go to this group for the simple reason that they control the most money. Sure, young people will make mistakes, but they don’t control nearly enough capital for it to make a difference. Do you think the young, inexperienced people caused the financial crisis? Of course not.

I’ve witnessed firsthand how easy it can be for very bright and experienced individuals to allow their past experiences to cloud their worldview. One of the biggest downsides of experienced practitioners is that many of them think they have everything figured out. It’s very easy for people to get stuck in their ways and not adapt with the world around them. Irrational ideologies are far more damaging to the decision-making process than inexperience.

This is why we had Depression babies who were risk averse for decades after the Great Depression. Investors who came up during the 1970s expected interest rates and inflation to stay high forever. Almost everyone who invested in the 80s or 90s became complacent and assumed mid-double digit stock market gains were their birthright. The latest generation of investors have decided that the world is going to end once a week because we’ve lived through two huge crashes in the past 15 years.

My hope is that young people have been paying attention to all the intelligent, more experienced people over the last few decades who have been wrong more than they’ve been right. Many of these people never bother to admit they’re wrong or learn from their mistakes so they continue to live in the past.

Before 2008, I had never experienced a massive financial crisis on a global scale. But no one else had either. It was truly unique aside from the fact that markets got pummeled. Just like no one had every experienced a tech bubble bursting…or a 1987 Black Monday crash…or something like the 1973-74 bear market.

The truth is every market scenario is different. No trader or investor has ever dealt with simultaneous stimulus packages and ZIRP policies from the world’s central banks like we’ve seen during this cycle. The best you can do — and this goes for experienced and inexperienced investors alike — is study as much market history as possible, stay humble and practice a heavy dose of self-awareness. And you also have to remember that studying market history is more about studying human emotions and irrational behavior than figuring out what’s likely to happen next.

It’s been said that ‘this time is different’ are the four most dangerous words an investor can use. That could be true depending on the context, but ‘I’ve seen it all’ can be pretty dangerous as well.