Review & Outlook

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The Costanza Principle: Do the Opposite of Your Instinct

6 August, 2014 by Ben O'Brien in Commentary

Yesterday stocks fell for the fourth time in five days. While the S&P 500 is still up almost 5% for the year, the gains in the Dow have been wiped out. Violence and turmoil across the world continues to trouble the markets. Your fearful instincts may be starting to kick in.

In the classic comedy show Seinfeld, the hapless but clever character George Costanza realizes one day that his instincts are so consistently wrong that if he simply does the opposite of whatever his instincts tell him, he will always do the right thing. He follows this principle for a while, and his life improves dramatically. All joking aside,  there is actually a lot of wisdom to the “Costanza principle” when it comes to investing.

(Source: Wikipedia)

Most of the time in investing our human nature is such that we are driven by fear or greed. Our minds are subject to all sorts of cognitive biases. (I highlighted one bias, “myopic loss aversion in a post the other day.)

If the market is going up we want to buy more. When the market is crashing we want to sell everything. Hindsight shows us, of course, that the opposite course of action would be the wise thing to do. Most of us wish we sold stocks at times when excitement for stocks was high such as 2000 or 2007. Likewise, we wish we had bought more stocks in times when things looked the bleakest such as 2001 and 2009. As Warren Buffet has famously said, “be fearful when others are greedy and greedy when others are fearful.” Of course, this is difficult to do because it goes against all our instincts.

Fear or greed lead us to want to time the market, predicting when the next crash or rally will happen. Virtually no one can consistently time the market, though, so it is wise to simply pick a suitable asset allocation and then stay the course, rebalancing the portfolio regularly. Thinking of the Costanza principle and acting against our instincts can help us stay on track and save us from acting rashly and emotionally.

This does not mean that we simply ignore negative events, but we make sure not to let negative events overshadow all the positives such as improving economic data and strong corporate earnings reports.