Identifying & Overcoming Cognitive Biases in the FIRE Community (Live CampFI) | MHFI 334

Mile High FI Podcast

Doug Cunnington reunites with Carl at CampFI to explore cognitive biases within the FIRE community, examining how mental shortcuts influence

Key takeaways

• Recency bias leads people to expect continued high market returns based on recent performance, despite historical volatility.
• The 2008 financial crisis is often forgotten due to its distance in time, leading to false confidence in current market conditions.

Main topics

• Cognitive biases in personal finance
• Recency bias and market performance expectations

Notable quotes

The stock market is the only store where people rush for the exits when it goes on sale.

Conclusion

Understanding cognitive biases is essential for making sound financial decisions in the FIRE

Transcript preview

Speaker 1 (0:04) Hey, what's going on? Welcome to the Mile High Fi podcast. I'm Doug Cunnington, and we are live here at Camp Fi Rocky Mountain, week 1.5. Woo! Speaker 1 (0:19) And it's really exciting. I heard Carl was going to be here, so I was like, I will come and I'll show up and we can record a podcast here together today. And it's been, I was going to say, it's been a while since you've been on. But then you reminded me we recorded like last week. But you used to open the show with something different than what I say. So will you do that? Speaker 2 (0:39) I have no idea what you're talking about. Speaker 1 (0:42) It's the hello world thing. Speaker 2 (0:44) Oh, hello world. Welcome to Mile High Five. Was that it? Speaker 1 (0:48) It was so anticlimactic. I thought it would be like, oh, we live in old times, but you don't even remember. Speaker 2 (0:55) No, it's been, it was a long time ago. Speaker 1 (0:57) That's okay. Well, Carl's here. We're going to talk about cognitive biases. We have about four that we're going to cover. We have a couple other wonderful co-hosts that are going to sit in with us today. So Amberlee Grant is here. How are you? I'm fantastic. And Kristen Knapp is here as well. Hello, Speaker 3 (1:14) it's great to be here. And oh my gosh, I love Camp Fire Rocky Mountain. It's my favorites. Speaker 1 (1:19) And I like to have a beer while I record these. So I'm just popping one open. And I think other people have beverages as well. Wine and some wine cooler. Carl, what do you have? Speaker 2 (1:29) Diet Coke. Speaker 1 (1:31) Well, that's really good too. So the four that we're going to cover are recency bias, arrival fallacy, anchoring around the 4 % rule and a fine number. confirmation bias and the echo chamber effect. Now, Carl, I think we kind of went back and forth on this idea, but you came up with the outline. What made you pick a couple of these for the cognitive biases we want to cover? Speaker 2 (1:58) AI made me pick them because I said to AI, what are the cognitive biases associated with PHI? And it spit out some ideas and then I honed them down and put them in this outline. Before we get too far into it, Doug, we should explain what one is because we did not even put that into the outline. And I think Kristen is going to bail us out here. Oh, Speaker 3 (2:17) on definitions? Yeah, yeah. Let me get my glasses on. Just what a Speaker 2 (2:19) cognitive bias is in the first place. Yes. Well, Speaker 3 (2:21) no, no, no. I just did the definition for confirmation bias, which is number four. So you might want me to hold that until we get to number four. Cognitive biases, I can Google right now. Stand by. Stand by. Speaker 1 (2:33) Anybody want to take a stab at defining it without looking at anything? Speaker 4 (2:37) Sure. I like to say yes. Courage. Cognitive biases. So, these are different ways that you can see the world based on how you've already seen it in the past, and so you projected to the future what that will look like in different, whether that's confirmation or recency. So, like things that have happened recently or confirmation, you have evidence from the past, so therefore you think that evidence will continue in the future. So that's my guess. Speaker 3 (3:06) I will tell you what Wikipedia says. A cognitive bias is a systematic error in thinking and judgment. Your brain relies on mental shortcuts to process millions of daily inputs quickly, which can sometimes result in irrational decisions, distorted perceptions, and flawed reasoning. It says understanding these subconscious patterns is crucial for recognizing why we sometimes draw the wrong conclusions in financial, medical, and personal decisions. Speaker 2 (3:33) So basically, we're going to tell people everything that's what's wrong with them. Speaker 1 (3:37) Yeah. And I think like another way to think of it, and you guys correct me if I'm wrong, it kind of explains why we would maybe make a bad decision. Even if we were seeing that in someone else, we're like, that's clearly a bad decision, but we don't see our own blind spots. Yeah. There. There's some overlap. And Speaker 4 (3:57) I'll just say this last thing, which is. in university we all learn economics, right? And that we are rational human beings and I think this shows that we are not rational and so behavioral economics and other things are actually a much better field of study when we're thinking of individuals and how we make decisions. Speaker 1 (4:15) Perfect. I thought your cold definition was pretty good. I would have believed it. You're confident. Speaker 4 (4:21) Hell yeah. Yeah. Speaker 1 (4:23) All right, Carl, you want to kick off like the recency bias and you have a few thoughts around this, right? Speaker 2 (4:29) Yeah. Our first one is recency bias. And this one is basically our thoughts are guided by what we've experienced recently. Hence the definition. But where it comes into play with the fire community is I was looking this up and during the past. 15 years, Kristen, do you have that? Well, you can see my screen. I Speaker 3 (4:46) know, I've already seen it. Make an Amberley guess. Amberley, do you have a Speaker 2 (4:49) guess of what the average return with dividend reinvestment of the S &P 500 was annualized for the past 15 years? What did every year return? Speaker 4 (4:58) I'll just guess 12.5%. Yeah, it Speaker 2 (5:00) was actually 14.2%. So we've lived, I don't know if there's ever been a period better than this. We've lived in this golden age and we're used to that. So we really haven't experienced much pain. We had a little... V-shaped depression during COVID where it crashed 30%, but then quickly came back up. So all of us are living in kind of, what's the word I'm looking for, Doug? Speaker 1 (5:20) I Speaker 2 (5:21) think we're probably, a lot of us are probably falsely overconfident because everything has been so good. Did Speaker 3 (5:28) you not experience pain though in 2008 or you just don't remember it? Speaker 2 (5:32) I did experience pain and I reacted very badly in 2008, but it was so long ago. Again, that was, how many years ago was that? It was 20 years ago, 18 years ago. Speaker 1 (5:41) What did you do that was so bad? Yeah, what did you do? Speaker 2 (5:43) I stopped. The market started to crash, and I stopped contributing to my 401k. So one of my favorite investing quotes of all time is from Warren Buffett. He said, the stock market is the only store where people rush for the exits when it goes on sale. And that's exactly what I did. The best time ever, I should have been investing. I completely stopped. Yeah, that was not good. Speaker 1 (6:02) Yep. And I did exactly the same thing. I think maybe I just cut down how much I was investing. But like you said, it would have been the best time to keep investing and like double down. But yeah, I was like, ah, the returns have been horrible for the last eight years, which is recency bias. And the other way, because I was like, ah, it's been shitty. It's probably going to keep being shitty. Speaker 3 (6:22) So I think the problem here is that because of this, maybe people use a higher number when they're doing their projections. I don't think I do. I mean, I'd be curious as to what you guys use. I use Speaker 4 (6:32) 8%. 8%. uh seven percent okay Speaker 1 (6:36) what Speaker 3 (6:37) well done yep Speaker 1 (6:38) and i think I think we use 4.93. Speaker 3 (6:43) What? So everyone's Speaker 1 (6:44) like, what? So we went to an advisor and generally CFP is out there. Do people or do advisors typically use something much lower than standard? Okay. So ours does. Yeah. So we're looking at that. When I do my shorthand, 8 % though. Speaker 2 (7:05) Carl? I have no number. We play it by ear. We wing it, which probably isn't great. Speaker 1 (7:12) Gotcha. Okay. Any observations on recency bias? What do you think, Avery? Speaker 4 (7:17) Well, I am younger than this panel. You're about 10 years Speaker 1 (7:23) younger, right? Speaker 4 (7:24) I don't know. Than me. I think so. Are we saying how old we are on air? We don't have to. Speaker 1 (7:31) No, we don't have to. Speaker 4 (7:32) I'm 38. And so I've only really, well, I've lived as in like, what, 2008 was I graduated. high school in 2007. So then 2008 happened and I remember it but it had no effect on me because I had actually invested money in the market but I didn't know anything about it. Speaker 4 (7:56) And I didn't invest for many years later. So it really wasn't anything interesting to me. So I've only been on this bull run from the time that I started investing. But I actually don't, I'll just say that my 7 % that I use could or could not be a good number, but I think it's not bad. Because I don't necessarily think that the market's going to continue to return this amount. I just feel like I live in a lucky golden age at this time that I was able to capture some of it because not a lot of it actually. I think I just feel grateful, but I don't anticipate this necessarily being the thing that moves forward. Speaker 1 (8:34) Makes sense. Speaker 4 (8:35) Yeah. Speaker 1 (8:36) One thing that I've seen is maybe people have too much in their equities because we have seen them just keep growing. Everything's great. And actually, I was recording with Pete, Mr. Money Mustache, recently. And I mean, I don't think he or you, Carl, have much cash on hand. You guys are like mostly equities. not much on bonds. Is that accurate? Speaker 2 (9:02) Yes. Speaker 1 (9:02) Okay. And it's like, it can be fine if you've over-saved, but if there's some correction and you're kind of on the edge, if you don't have any bonds or any cash, then you may have to go back to work, which might not be a big deal. Like we're flexible. You can go back to work. But if you're like, oh yeah, everything's been awesome. People are telling me, just be positive, like be optimistic. The market just keeps going up. Well, I mean, it could be like two or three years where there's a recession and I'm not, saying I'm pessimistic or anything, but like if the consequence is going back to work, then you have to figure out if that's worth it to you. So what do you think, Carl, as someone who has mostly equities? Speaker 3 (9:40) What would you do if the market dropped like 40 % tomorrow? What are you doing? You're okay selling into a down market because you've over-saved so much? That's okay? Speaker 2 (9:46) Yeah, we'd be okay with it. But actually, we talked to financial advisors a couple weeks ago, and we are starting to move more things into cash. We have big spending years with two kids in school soon, so we are moving more. Is Speaker 3 (10:00) there Speaker 2 (10:00) a percentage you're Speaker 3 (10:00) aiming for in cash? Speaker 2 (10:02) Probably 5%. Okay. Speaker 4 (10:04) I'm curious on this one on real estate, because I do think that recency bias in the real estate world is much more impactful in the short term. So we had a massive run-up in real estate since 2008, and young people getting in thinking that 20 %... year over year appreciation is normal. And I think a lot of people are getting caught right now in that, I don't want to say it's a bubble, but in that issue. And I see it because I'm part of the real estate investing community in Denver and Denver itself has gone down 20%. Rents have gone down 20%. And they bought two years ago with these short-term rental ideas and all this stuff. And I'm seeing that play out, I think in my world, in my generation, very much in real estate. Speaker 1 (10:51) Perfect example. Speaker 4 (10:52) Yeah. Speaker 3 (10:52) I don't dabble in any real estate. I have no thoughts. Do you guys have any thoughts on that? No. Speaker 1 (10:57) No, I mean, it makes sense. It totally makes sense. Yeah, and then Kristen, anything with a recency bias? Speaker 3 (11:04) No, but we're all very fortunate as to what we've been able to experience the last, what, since, we said since 08 we've been on this run? Speaker 1 (11:13) Yes. When did it Speaker 4 (11:14) start? Speaker 3 (11:14) 08? Speaker 4 (11:15) I Speaker 3 (11:16) think 2010. Speaker 1 (11:17) Yeah, that sounds right. Yeah. Oh wait, it was like the bottom. Okay, so Speaker 3 (11:19) 16 years at least. Yeah, we're pretty Speaker 4 (11:22) fortunate individuals. Speaker 2 (11:23) Yeah, very fortunate. There were a couple of backups. Speaker 4 (11:26) I have a question then. If we are very fortunate, and when we're talking about this, you're using a 4.92, and we're talking, do you actually have any connection to a possible recession? But it sounds like neither, both of you would not actually be affected whatsoever. I would be affected. Going back to work is probably not an option during a recession anyways, because jobs are probably not prevalent. and even out of the workforce and no one's quitting their job at that time. So, do you actually think that you're affected and is this like any, do you have any emotional attachment to this? Speaker 1 (11:56) Not too much. I don't think I mean. I wouldn't be too impacted. It's more of a thought exercise. But yeah, to your point, like we use something so conservative that it. Yeah, it wouldn't really matter. Speaker 3 (12:08) My plan is to, I'm still working, so I haven't moved it around like this quite yet, but my plan is to have roughly maybe 70 % in equities, maybe 20 % in bonds, 10 % in cash, so that if we got into a down market, we would have the cash and bonds that we'd offer for quite some time before we'd ever have to sell into a down market. That's my plan. But, yeah. where we've got like right at the right amount, not over-saved. It sounds like if you're over-saved, you don't have to worry about it as much. Right. Speaker 1 (12:37) And bear in mind, my wife would answer completely different than me. Yeah, Speaker 3 (12:41) totally. And can you elaborate? Speaker 1 (12:44) if there was like a big recession, she would probably be like, maybe we're going back to work. And I'm like, I don't, I don't really, I don't think so. I don't think so. But, but she would be like, yeah, maybe, maybe we should. Speaker 3 (12:56) And then that's when you call your advisor and say, please tell Elizabeth where we're at. Right. And Speaker 1 (13:00) that is part of the strategy of having an advisor. There's an intermediary. There's like at least two sane people. I won't say which two, but at least two sane people and she would also describe that differently Speaker 4 (13:12) as well. But Speaker 1 (13:14) the advisor has been good and we've met in the middle through those negotiations. Speaker 4 (13:20) Can I ask another question? Speaker 1 (13:22) Yeah, yeah. This is great. That's why you're here. Speaker 4 (13:24) Would you guys ever, like you wouldn't need to, but let's just do this thought experiment yet again. And we're going to add. Would you ever then move to maybe a lower cost of living area to allow yourself more time? Is that something that you felt comfortable doing and that might be country and or part of this? Like other country or part of that's like a Speaker 3 (13:43) hardcore. Yes for me. Yeah all day every day Just because I want to do that anyway, right? So it give me a great excuse to go live in some exotic place for a while, right? Yeah, and just only Speaker 4 (13:51) piece it out on a beach for a while. See what happens. Yeah, I'm in a Speaker 3 (13:55) silent for a few years. Yeah, Speaker 4 (13:56) we're Speaker 1 (13:57) like, Mississippi I actually Speaker 3 (14:01) lived there for a few years. I'm good on Mississippi, but maybe Portugal What would you do? Speaker 2 (14:08) Yeah, I think we've considered doing that as well, spending time in other parts of the world, and that'd be a great excuse to do it, although I would not want to be forced into doing it, but why not? Speaker 1 (14:20) Yeah, yeah, definitely an option. I mean, that's one of the... Things that we would be flexible on. Speaker 4 (14:26) Yeah, as location. Speaker 1 (14:27) Yeah, for sure. Speaker 4 (14:28) Because you have to do that, right? If something were to happen in the future, flexibility will be the thing that gets you through it the best. Speaker 1 (14:34) Yeah. And how about you? Speaker 4 (14:36) Oh, fuck yeah. Speaker 1 (14:37) And you do some travel anyway, right? Oh, yeah. Speaker 4 (14:41) With Speaker 1 (14:41) long-term... Speaker 4 (14:43) Yeah. Speaker 1 (14:44) Do you want to share a quick example? Well, Speaker 4 (14:46) I'm Canadian. So if the U.S. goes to shit and Canada is still okay, I'll just hop up there. Although my Canadian dollar may not, or my American dollar may not go far. I'm also very happy to live abroad, maybe work on my Scottish citizenship at that time or something. Like there's, I find there's, the world is very open and inviting place in my mind and how I've experienced it. So I would be happy to review it. Check it out. Speaker 1 (15:11) All right, I think we're ready to move on to number two, which is arrival fallacy. And Carl, I think you thought long and hard about this one, right? Speaker 2 (15:20) Yeah, this is one I actually went to not chat GPT, but chat GTP, P-E-E. And this is called the arrival or white asparagus fallacy. Have you heard of that term before? Speaker 1 (15:31) No, I haven't. I've heard of white asparagus. Yeah, yeah. Speaker 2 (15:34) Okay. So this basically is we assign too much value to something because it's harder to get, like the grass is greener on the other side. And what I discovered in my Chad GTP research is a lot of people think white asparagus doesn't make your pee smell. So a lot of people want it. But that's not actually true. I guess, like, it's in Germany, right? You can find the whitest variant. Didn't you Speaker 3 (15:56) say somebody sent you some? Did you try it? Did you experiment? It is a Speaker 2 (15:58) delicacy. I don't think I've opened it. Like, Darren and Jolene gave us that tin. Hopefully it's got a long explanation. But we have a surprise. Speaker 1 (16:03) Everybody reach under your seat. Speaker 2 (16:08) But how this plays out in the FI community is a lot of people build financial independence up to this huge thing. I can't wait to hit my number. And then you hit your number and it's like, this is exactly like yesterday and tomorrow will probably be the same, except we've hit this magical kind of fake number in our head. Do you remember when you hit your number, Doug? Speaker 1 (16:28) No, I have no idea. Speaker 2 (16:30) Exactly. Anti-climactic. And Speaker 1 (16:32) I think, well, I do want to go back. How did they make the asparagus white? Speaker 2 (16:37) I do know how they do this. They pile dirt around it so the poor asparagus is never exposed to sunlight. fungus. So it never developed chlorophyll. Yeah, it's in the dark its whole life. And I've never actually had it. Have you? Speaker 1 (16:50) No, no. And I