The Ninth Major Axiom : On Optimism and Pessimism

The Zurich Axioms By Max Gunther

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Optimism means expecting the best, but confidence means knowing how you will handle the worst. Never make a move if you are merely optimistic.

Optimism has always had a good press. It is felt to be a nice trait to have. Optimistic people are cheerful souls, good company in gloomy times. During the Great Depression of the 1930s, there was a nationwide network of Optimist Clubs, whose appealing doctrine was that things would get better if only people believed they were getting better. The Depression did go away after a while, and some optimists said, “See? It worked!” Perhaps optimism did playa role – with a helping hand from the Second World War. But you had better be very careful about the role optimism plays in your personal financial life.

A general feeling of hope and good expectations cannot do you any harm. “I’ll learn. I’ll do well. I’ll make it.” Indeed, without that fundamental buoyancy, how could one be a speculator at all? But be extremely wary of optimism as it applies to specific money ventures. It can be a dangerous state of mind.

Professional gamblers know this. It is one of their most effective tools for emptying the pockets of amateurs.

In poker, if a pro arrives at a situation in which the odds say he shouldn’t bet, he doesn’t. He folds. This means he must abandon what he has so far contributed to the pot, but it saves him from a bigger loss.

In the same situation, the amateur gets befuddled by optimism. “Maybe I’ll be lucky”, he thinks. “Maybe I’ll draw my card …. Maybe the guy across the table is bluffing about that doughnut straight of his …….”

Once in a while, of course, the amateur does get lucky. What the odds said probably wouldn’t happen does happen. The amateur beats the odds just often enough to keep that crazy optimism alive. And so he keeps investing his money in losing hands. You can beat the odds once in a while but not consistently. Usually, if the odds say you’ve got a loser, it’s a loser. The pro, knowing this, and knowing how easily the optimistic sucker can be persuaded to bet when he shouldn’t, gets rich.

The pro doesn’t have optimism. What he has is confidence. Confidence springs from the constructive use of pessimism.

An optimist, descending into the valley of the shadow, puts on a brave smile and says, “Things never are as bad as they seem.” Or instead of saying it, sings it. Almost as many songs have been written on that theme as on unrequited love. It is certainly a nice gooey theme, but don’t ever let it get mixed up with your financial philosophy. In poker and a lot of other speculative worlds, things nearly always are as bad as they seem. A lot of time, they’re worse. They are worse at least as often as they are better. You can bet on better if you like, but in the absence of tangible evidence to the contrary, you’re being overoptimistic. The safest course, almost always, is to assume that if a situation looks bad, it is.

“Never make a move if you are merely optimistic”, says the Axiom. Seek confidence instead. Confidence comes not from expecting the best, but from knowing how you will handle the worst.

The poker pro knows what he is going to do if the cards fall against him. Of course, he hopes they won’t, but he doesn’t let his fate ride on that hope. He goes into the game trained and prepared to act sensibly in case his luck of the draw is bad. That’s what is meant by constructive pessimism.

In contrast, let’s look at the sad saga of a young married couple who thought optimism was enough. We’ll call them Sam and Judy. Their story was told to me by a San Francisco-suburban real estate saleswoman.

Same and Judy were fairly typical of the breed sometimes labeled yuppies – young urban professionals. Sam was an advertising man, Judy a pediatric resident in a hospital. They nursed big dreams. Sam wanted to found his own ad agency some day, while Judy planned to get into private practice. Possessing a healthy streak of acquisitiveness, they talked frankly of getting rich. To hasten that day, they had begun early in their married life to expose their spare money to risk.

They hadn’t done too badly at first, considering their lack of skill as speculators. Luck had been with them. Over a span of several years they had managed to double their nest egg which, when they married, had consisted of two savings accounts of totaling about $12,000. They had parlayed it up to $25,000 or so. Then their luck ran out.

They learned about a vast land development in a southwestern state. Lots of various sizes from half an acre up were being offered as homesites or for investment purposes. The development corporation, however, had overextended itself. Roads had been built and utility lines extended into one area of the vast tract, as promised, but then the company had run out of money. Much of the tract was still nothing but an untouched wilderness of semidesert.

To raise the cash it desperately needed, the corporation had progressively dropped the price of lots in the unimproved part of the development. Outlying lots were being offered at prices that seemed astonishingly low when compared to prices in the improved segment.

Sam and Judy studied this interesting situation with a good deal of excitement. By using most of their nest egg, they could buy an impressively big acreage in that outlying area. By reselling lots when the time came, they could double or triple their money in a short time – if.

If these promised roads ever got built. And if those utility lines ever made their way to the outlying area.

It was a gamble on the fate of the development corporation. If the company regained its health, and if various legal questions were resolved in its favor, and if a number of other things, then, in time, roads and utilities would push their way out to the lots Sam and Judy were looking at. But if things went badly, those lots might be inaccessible wilderness forever.

The company’s sales literature and salespeople made promises, of course – or to put it more accurately, mumbled encouraging phrases that sounded like promises but didn’t legally bind the company to do anything: “It is anticipated ……. the directors believe …..” Sam and Judy weren’t naive enough to be taken in by this. They were aware of the risks. The corporation might go bankrupt. Or the shareowners might simply vote it out of existence, pick up the residual cash, and scatter like seeds in the wind. In such a case, Sam’s and Judy’s land would be worth even less than the bargain price they were paying for it. It might even turn out to be just unsalable. Their money could be trapped in it for the rest of their lives.

But they though the risk was worth taking. They were optimistic.

There is nothing wrong with taking a risk, of course. To bet one’s money on a venture whose outcome cannot be foreseen: this is the basis of all speculation. As we’ve learned in studying other Axioms, just about all ventures have unforeseeable outcomes. There are no reliable patterns in human affairs. No forecast can be trusted. Whether you’re buying IBM stock or undeveloped land, you’re still gambling. In putting their money at risk in hope of a gain. Sam and Judy weren’t doing anything that isn’t done daily by all those supposedly Wall Street people who like to call themselves “investors”.

But Sam and Judy made one fundamental mistake. They weren’t pessimistic enough. They didn’t ask how they would save themselves if the cards fell against them.

Buying IBM stock is a gamble, but there is a way to save yourself if the venture sours. You sell out. We noted under the Third Axiom that this isn’t the easiest thing in the world to do, but at least the chance to do it is open to you. There is always going to be somebody to sell to, for there is always somebody making a market in IBM shares. Walking into the venture, you can mark the exit: “I’ll get out if the price drops to such-and-such.”

Knowing how you will handle the worst: that is confidence.

Sam and Judy could have made an exit for themselves if they had been less optimistic. The land they were looking at was more than a mile from the developed segment, where the paved roads ended. This distance was part of the reason for the extremely low price. Other undeveloped plots were also for sale, closer to the developed segment but at correspondingly higher prices. Sam and Judy could have bought some of this higher-priced land. Then, if the corporation failed to make good on its promises, they could have made their land usable and salable by putting in their own relatively short access road.

If they had to do that, they might come out of the venture with a loss. But at least they would be able to get out.

Instead of thinking about that gloomy possibility, they bet on their optimism alone. The situation seemed fully to promise to them. If the development corporation recovered from its difficulties and carried out its announced plans, which Sam and Judy found every reason to believe it would, they and other holders of outlying plots stood to make an eye-popping gain. And so Sam and Judy walked into a venture with no exit.

That was many years ago. The corporation no longer exists. Nor do the promised roads and utility lines. The state attorney general’s office has been trying to track down the company’s principals and force an accounting from them, but with little success so far. Meanwhile Sam and Judy are stuck with a lot of land that can only be reached on foot or on horseback and seems likely to remain that way.

They may never sell it. They and other owners of outlying plots have talked about sharing the cost of access roads and utilities, but nothing ever gets done. The projected costs are high and while some property owners seem willing to pay their share, other’s aren’t. Sam and Judy, betrayed by optimism, are in what could be a life-long trap.

One reason why optimism is so treacherous is that it feels good. It feels much better than pessimism. It has a hypnotic allure. It is like the Sirens of ancient Greek legend, whose sweet singing lured sailors to death on the rocks.

Any venture, as you begin it, has a limitless number of possible futures, some good and some bad. The good ones and the bad ones are equally likely. You’re as likely to go down as up. But which kind of outcome feels the more likely to you? The good kind, of course.

Optimism is altogether human and probably incurable. Peering bling-eyed into an impenetrable future, we hope for the best and talk ourselves into expecting the best. Perhaps life would be impossible without optimism. Speculation would be impossible too. The very act of betting money is a species of optimistic statement about an unknowable outcome. This is the paradox of it: optimism, which feels so good and may even be necessary, can lead to financial doom if allowed to get out of control.

Not only does it lead to Sam’s and Judy’s kind of doom, but it is a leading cause of pervasively flawed judgment. This is illustrated every business day on Wall Street. No matter what the stock market happens to be doing on any given day, there are always optimists around saying the next great bull market is going to start next week. There are also pessimists saying it isn’t. Who gets listened to? Most often the optimists, for their song is the sweeter.

You can check this for yourself. Great financial newspapers such as the Wall Street Journal and the New York Times publish columns of stock market news, gossip, and opinion every day. The business journalists who write these columns hit the phone every afternoon when the markets have closed. Calls go out to brokers, analysts, and others who can be expected to comment knowledgeably on the day’s trading. Each journalist has a list of favorite people who can be buttonholed for this purpose. On what basis does the journalist decide who to call? What qualifies somebody for a position at the top of one of these lists? Mainly three things: accessibility, articulateness, and optimism.

By my own informal count over a period of years, at least three-fourths of the market readings reported in these column are optimistic. This is a decidedly lopsided showing, since, from any given day’s viewpoint, the market’s future is just as likely to be bad as good. There should be pretty nearly an equal number of bears and bulls around. Yet if we are to go by the newspaper columns, bulls are vastly in the majority. Why? There are two explanations:

First, bulls do, in fact, outnumber bears – by a very big margin. The reason for this is, of course, that optimism feels better than pessimism. So even if a conscientious journalist were to beat the bushes for an equal number of quotable bears and bulls, with the object of writing a carefully balanced report, he would be frustrated by the fact that bulls are considerable easier to find.

Second, financial journalists don’t usually seek equal bull bear representation in any case. Why not? Because they prefer interviewing bulls. The song is sweeter. So even if there were an equal number of the two species wandering about on the Street, the bulls would still be over represented in the reports.

The more bullish of the bulls get quoted over and over again by everybody. There is one man whose name appears in the papers or on radio or TV business reports at least once every two weeks. He is an officer of one of the Street’s biggest and older brokerage houses. He is such an amiable soul, and the song he sings is so beautiful, that I don’t want to embarrass him or tarnish his image by naming him here. It would be sinful, one feels, to risk souring that music.

The journalists keep going back to him because he is such a die-hard optimist. The fact that he is usually wrong doesn’t seem to upset anybody or diminish his appeal. All through 1980 and 1981 he kept doggedly predicting that a bull market was about to start. It didn’t, but the journalists kept quoting him. He finally became right in August 1982. The bull market arrives, then petered out in the spring of 1983. Never mind, said this cheerful soul, all we’re seeing is a temporary pause in the bull market! He kept saying that the Dow Jones Industrial Index would soon top 1300. It didn’t. By the first quarter of 1984 it was slumping toward 1100. But this only made the quotable fellow stoke up his optimism all the higher. All it took was one good day in the market to convince him that paradise was at hand. Early in April, after weeks and weeks of gloom, the Dow managed to jump some twenty points in one day’s trading. The optimist was quoted in the New York Times as saying that this was the beginning of the second great leg of the bull market.

The next day, the Dow gave up about half of its twenty-point gain. The day after that, it gave up the rest.

The promised ‘second leg’ seemed to be delayed a bit. But this didn’t seem to perturb the optimist or diminish the number of journalists’ call coming in on his phone. A week or so later, he was singing his cheery song into the ear and typewriter of a Wall Street Journal reporter.

Thus does the exasperating human psyche operate. We are drawn to optimism and optimists. They plainly don’t know any more about the future than pessimists do, nor can we ever assume, in choosing between the two, that the optimists are objectively more worth listening to. Yet, as you will learn if you haven’t already, it is the optimists to whom you would prefer to lend your ear.

There are optimists all around you, and there is undoubtedly a very insistent one inside your head. Watch out for them all. They can befuddle your good judgment to an alarming degree.

In the old legend, Odysseus got his ship safely past the Sirens by plugging his crewmen’s earns with wax and having himself roped to the mast. No such defense is effect against the song of the optimist. You will never block the song out entirely, for you are, after all, human. What you can do is to stay aware of the optimistic bias is your internal compass and stay alert to its dangers.

When you’re feeling optimistic, try to judge whether that good feeling is really justified by the facts. At least half the time, it won’t be.

Speculative Strategy

The Ninth Axiom warns that optimism can be a speculator’s enemy. It feels good and is dangerous for that very reason. It produces a general clouding of judgment. It can lead you into ventures with no exits. And even when there is an exit, optimism can persuade you not to use it.

The Axiom says you should never make a move if you are merely optimistic. Before committing your money to a venture, ask how you will save yourself if things go wrong. Once you have that clearly worked out, you’ve got something better than optimism. You’ve got confidence.