The document discusses how difficult it is for people to accurately predict how they will respond to future risks and challenges. It provides the example of a friend who achieved his goal of becoming a doctor against all odds, but is now disappointed in his career. People are poor forecasters of their future selves and tend to ignore important context when anticipating future situations. Investors in particular struggle to predict how fearful or greedy they will feel during market downturns or surges. The best approach is to use past behavior as a guide rather than trying to envision hypothetical future responses.

1. It’s Hard To Predict How
You’ll Respond To Risk
Jan 31, 2018 by Morgan Housel
I grew up with a friend who came from neither privilege or natural intellect, but was the
hardest-working guy I knew. These people have a lot to teach because they have an
unfiltered understanding of every inch of the road to success.
His life’s mission as a teenager was to be a doctor. To say the odds were stacked against him is being charitable.
No reasonable person at the time would consider it a possibility.
But he cranked. And – a decade older than his classmates – he eventually achieved his dream of becoming a
doctor.
How much fulfillment comes from starting from nothing, bulldozing your way to the top of medical school, and
achieving one of the most noble professions against all odds?
I spoke to him recently for the first time in years. I wish I recorded the conversation, because it was an
exposition in psychology and risk. It went like this:
Me: “Long time no talk! How you doi–”
Him: “Awful career.”
Me: “Haha, well–”
Him: “Awful career, man.”
This went on for 10 minutes. The stress, the hours. It wore him out. There was exaggeration and missing context.
But he seemed as disappointed in where he is today as he was driven toward where he wanted to be fifteen years
ago.
An underpinning of psychology is that people are poor forecasters of their future selves. There is all kinds
of research backing this up. Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life
stresses that grow with competitive pursuits is hard to do, and miserable when you can.
This impacts business and investing, where most actions require not just anticipating rewards, but anticipating
how you’ll react to future challenges.
The whole idea of investing risk is imagining a future filled with potholes and assuming you will either see it
coming and avoid it – “I won’t be greedy” – or anticipating your ability to accept and exploit it – “I’ll see it as an
opportunity.”
I’m here to tell you: This is really hard to do. And it bedevils our decision-making.

2. Best Buy stock is up more than Amazon stock in the last five years.
Blackberry stock is up more than Apple stock in the last four years.
Hawaiian Airlines stock is up more than Facebook stock over the last five years.
If you’re surprised by these numbers it’s because it’s natural to think in away that follows the most logical path
of least resistance. Here that means assuming outcomes are driven by underlying events. Apple’s products have
done well. Best Buy’s services have not. The investing outcome should look the same.
What this misses – and this is as obvious as it is easy to forget – is that investing outcomes are driven not just by
business results, but business results within the context of expectations. Five years ago we expected nothing
from Best Buy and everything from Apple. So Best Buy gets a bigger trophy for showing up to the game than
Apple gets for being MVP.
The point is it’s easy to oversimplify a forecast because important context can be counterintuitive and easy to
ignore.
The same disconnect happens when you try to forecast how you’ll respond to future risks.
How will I respond to the next investing downturn?
The logical path of least resistance is assuming I’ll view it as an opportunity. Cheaper valuations! Higher future
return expectations! Isn’t this what most of us were brought up to want?
But the distance between me anticipating what a downturn will feel like vs. actually being in a downturn is ten
miles wide.
The easiest way to think about a downturn is to imagine a world where everything’s the same as it is today
except for valuations, which, in my dream, are like 30% cheaper than today. This is the logical path of least
resistance.
It is exponentially harder to imagine a world where a downturn is caused by something that scares me as much
as those who are driving valuations down. It’s even harder to imagine a world where I see opportunity but those
I trust and rely on – a spouse, or outside investors, or coworkers – convincingly urge me to be cautious. And it is
mental anguish to properly imagine a world where a downturn is caused by something I participated in –
especially if that something made me a lot of money today. It’s easy to ignore this context when trying to
anticipate the future. But it’s the single most important part of determining that future.
Daniel Kahneman makes this point when discussing how bad we are at predicting happiness. We dream about
different circumstances in a vacuum while ignoring negative factors that come along with those circumstances.
Dreaming about sitting on a beach brings more joy than actually being on a beach, because in the dream you’re
not thinking about getting bit by mosquitos, or having heartburn from lunch, which is what happens in the real
world.
The same thing happens on the way up in investing. I don’t think any investor feels as good today as they
thought they would if you told them ten years ago that we’d have a decade of nearly uninterrupted gains, because
ten years ago it was hard to imagine what would be occupying your mind in 2018 besides your gains – bad
weather, or traffic, or paying taxes on your gains, or the threat of a new downturn. Jeff Immelt explained the
business version of this after he left GE: “Every job looks easy when you’re not the one doing it.”
All of which is to say:
You will likely be more fearful when your investments are crashing and more greedy when they’re surging than
you anticipate.
And most of us won’t believe it until it happens.

3. What do we do if we’re poor predictors of our future selves?
Years ago, psychologist Dan Ariely was asked by a group of financial advisors for advice on how to better serve
clients.
“The craziest thing you guys do is the risk assessment questionnaire,” he said.
The questionnaire asks clients how they’d feel if they lost 10%, 20%, or 30% of their money, and builds a
portfolio off the results.
It relies on people accurately predicting how they’ll feel if they lost money in the future. Which is extremely hard
to do when the economy is booming.
A better approach is using your past behavior as a guide to your future behavior.
Past behavior includes more context of how the world works than you get when trying to envision future
behavior. It’s also based on the idea that how people react to outlier events – booms, busts, stress, joy – is driven
more by emotions that are stable in time than intelligence that evolves over time.
How you responded to the last big loss, or the last big win, or the last stressful project, or last time you lost
control of your schedule, is probably a good indication of how you’re likely to respond the next time it happens.
One of my favorite ideas is that people should read more history and fewer forecasts. That’s not just true about
business and investing topics, but for ourselves as well.