You Have To Live It To Believe It Part 1 of 2
By Morgan Housel Apr 9, 2019
Richard Held and Alan Hein raised 20 kittens in pitch black darkness. Which is the kind of thing you should only do if it’s necessary to prove a point critical to understanding how the world works. Thankfully they did just that.
The two MIT cognitive scientists, working in the 1960s, showed that seeing the world around you was not enough to understand how it works. You had to actually experience that world to learn how to operate in it.
The scientists raised cats in total darkness to control the relationship between seeing and learning. Once a pair of kittens were old enough to walk, they were placed in a lighted box for three hours a day.
In the box was a kind of carousel, with each kitten placed in a harness. One of the cat’s legs reached the floor, and its walking movements made the carousel move in a circle.
The other cat’s legs were restrained by the harness. It could see everything going on – the movement, the other cat walking around in circles – but its legs never touched the floor. It had no active control over the carousel.
After eight weeks of daily carousel walks the cats were brought into the real light-filled world to test what they had learned.
They were tested to see if they’d automatically place their paws on a surface they were about to be set down upon.
And if they’d avoid a steep ledge, walking around to a gradual ramp instead.
And whether they’d blink when an object was quickly brought close to their face.
The results were extraordinary.
100% of the cats whose legs had control over the carousel’s movements tested normal.
The cats who only watched, but never controlled, the carousel were functionally blind.
They bounded towards the steep ledge and fell straight off. They didn’t put their paws out to land on a surface. They didn’t blink when an object accelerated toward their face.
It wasn’t that they couldn’t operate their bodies – they learned to do that in the dark room they were raised in. But they couldn’t associate visual objects with what their bodies were supposed to do.
The two cats grew up seeing the same thing. But one experienced the real world while the other merely saw it. The result was that one was normal; the other was effectively blind.
One of the most important topics in business and investing is whether all of us are, in some ways, like these blind cats.
Sure, we’ve read about the Great Depression. But most of us didn’t live through it. So can we actually learn lessons from it that make us better with our money?
Sure, we all know about the 2000 dot-com bust. But many – maybe most – investors and founders weren’t active back then. So do they actually understand the power of bubbles as well as those who did live through it?
My generation, the millennials, has never experienced significant inflation. We can read about gasoline lines of the 1970s and 15% mortgage rates in the 1980s.
But am I as concerned about monetary policy as the Baby Boomer who does remember those things? And is the Baby Boomer as concerned as the Venezuelan who’s experienced hyperinflation?
The answer to these questions is – at best – maybe.
I say it’s one of the most important topics because it affects everyone. What I’ve experienced as an investor is different from what you’ve experienced, even if we’re from the same generation. And the generation and country you’re born into, the values instilled in you by your parents, and the serendipitous paths we all wander down are out of our control.
Investor Michael Batnick says, “some lessons have to be experienced before they can be understood.” We are all victims, in different ways, to that truth.
This report digs into the effect difference experiences we’ve had have on our ability to make smart decisions about business and investing risk.
Part 1: Blind Spots
Two events shaped the 20th century: The Great Depression and World War II.
The 1960 Democratic primary pitted a man who didn’t experience the former against a man who didn’t experience the latter. And voters took note.
John F. Kennedy grew up in one of the wealthiest American families, and the rare clan whose wealth surged during the Great Depression. His father Joe Kennedy’s life goal was to make so much money that his kids could devote their life to politics. He did just that.
In 1960 journalist Hugh Sidey attempted to gauge Senator Kennedy’s economic credentials. “What do you remember about the Depression?” Sidey asked. JFK responded candidly:
I have no first-hand knowledge of the depression. My family had one of the great fortunes of the world and it was worth more than ever then. We had bigger houses, more servants, we traveled more. About the only thing that I saw directly was when my father hired some extra gardeners just to give them a job so they could eat. I really did not learn about the depression until I read about it at Harvard.
Kennedy then leaned forward and told Sidey, “My experience was the war. I can tell you about that.” He then recounted his battle experiences for more than an hour.
Sidey later reported:
If I had to single out one element of Kennedy’s life that more than anything else influenced his later leadership it would be the horror of war, a total revulsion over the terrible toll that modern war has taken on individuals, nations and societies. It ran ever deeper than his considerable public rhetoric on the issue.
Kennedy ran against Hubert Humphrey, whose personal history was an almost mirror image of his own.
Humphrey was born in his father’s store in Wallace, South Dakota. It didn’t get much better from there. Smacked by the Great Depression, he was forced to drop out of college after a year to help his father keep the store afloat. He struggled financially for the rest of his life.
It had a lasting impact on his thinking. During the campaign Humphrey said he learned more about economics from one dust storm during the Depression than he did in all his college economics courses combined (he later finished his degree).
Humphrey could relate to everyday Americans and their money problems in a way Kennedy never could -– a point he repeated often during the campaign.
But unlike Kennedy, Humphrey did not see combat during World War II. He was turned down by the Army and Navy because of colorblindness and hernias.
The Kennedy campaign turned the tables and used Humphrey’s lack of war experience as evidence that he didn’t understand something that was central to Americans’ lives.
They created what was almost certainly a false narrative that Humphrey was a draft-dodger – unforgivable to American families who lost almost half a million soldiers in the war. Stumping for Kennedy, Franklin Roosevelt Jr. told crowds: “There’s another candidate in your primary. He’s a good Democrat, but I don’t know where he was in World War II.”
Both campaigns used the same logic: someone who merely read about a big event cannot fully empathize with those who experienced that big event.
Which is a point that comes up often in investing.
Two years ago Marc Andreessen said that tech stocks have been undervalued for most of the last 15 years. It partly explains why they’ve produced great returns. The cause of undervaluation, he explained, was the mental scars left by the dot-com implosion in 2000.
“If you live through one of these scarring crashes, you get psychologically marked,” he said. It scarred investors, founders, journalists, regulators, everyone. Investor Tren Griffin wrote:
I have a lot of muscle memory that resulted from the Internet bubble. There is no way you can fully convey in words the experience being in the lead car as an investor in that roller coaster. Looking at the cycle after the fact is nothing like looking ahead and not knowing what will happen next. The experience still impacts the way I think and act.
That last point is important, because something began changing in Silicon Valley over the last few years. Andreessen again:
One thing that’s happening is now enough time has passed that enough kids are coming to the Valley who don’t have a memory of the crash. They were like in 4th Grade when it happened. We get in these weird conversations where we’re telling them cautionary tales of what happened in 1998, and they look at you like you’re a Grandpa.
We have a new generation of people in the Valley who say, ‘Let’s just go build things. Let’s not be held back by superstition.’
This new generation might help explain why Silicon Valley risk-taking grew over the last five years. The number of VC funds, the number of VC-backed deals, the valuations those deals fetch, and the number of college grads to get into startups has surged.
The typical Silicon Valley founder in your head might look like a 21-year tinkering in their dorm room, and some are. But the median age of a startup founder is actually 40.
Yet even a 40-year-old was likely in college during the dot-com rise and fall. They avoided the carnage. So they think about risk and reward in totally different ways than a 40-year-old founder did five or 10 years ago.
This is not just anecdotal.
In 2006 economists Ulrike Malmendier and Stefan Nagel from the National Bureau of Economic research dug through 50 years of the Survey of Consumer Finances – a detailed look at what Americans do with their money.
In theory people should make investment decisions based on their goals and the characteristics of the investment options available to them at the time (things like valuation and expected return).
But that’s not what people do. The research showed that people’s lifetime investment decisions are heavily anchored to the experiences those investors had with different investments in their own generation – especially experiences early in their adult life.
Our results explain, for example, the relatively low rates of stock market participation among young households in the early 1980s (following the disappointing stock market returns in the 1970s depression) and the relatively high participation rates of young investors in the late 1990s (following the boom years in the 1990s).
This holds true across asset classes. Ten-year Treasury bonds lost almost half their value from 1973 to 1981, adjusted for inflation. Those who lived through these blows invested considerably less of their assets in fixed-income products than those who avoided them due to the luck of their birth year.
Back to my generation, the Millennials, who have never experienced inflation: When we invest on our own, we put 59% of our assets in cash and bonds, and 28% in stocks, according to UBS Wealth Management.
And of course we do: Many of us started making money in the teeth of the Great Recession and the largest bear market in generations, which also happened to be the period when bonds not only preserved but grew wealth as interest rates fell to 0%. That’s our history. That’s what we know. And what we know is more persuasive than what we read.
The Financial Times interviewed Bill Gross, the famed bond manager, last month. “Gross admits that he would probably not be where he is today if he had been born a decade earlier or later,” the paper wrote.
His career coincided almost perfectly with a generational collapse in interest rates that gave bond prices a tailwind. That kind of thing doesn’t just affect the opportunities you come across; it affects what you think about those opportunities when they’re presented in front of you.
This was Andreessen’s point: In hindsight we know tech stocks were undervalued for most of the 2002-2015 period. But the generation that lost most of their money in the tech bust didn’t even recognize that opportunity. It took a new generation who lacked the scars of the bust to see it.
Our own unique experiences impacts more than just investing behavior.
In a study of men graduating from college between 1979 and 1989, Yale economist Lisa Kahn found that those entering the labor market during poor economic times earned 7% less than those graduating in a strong economy.
That gap lasted seemingly indefinitely: 17 years after graduation, Kahn found those who began their careers in recession still earned less than those who began when the economy was strong. You can imagine that a group who experiences that kind of pain will have different views about economic policies than a group who happened to graduate during a booming economy.
And it’s not because one group is smarter than another; most of it is just the chance of what generation they were born into. Where you were born matters too. European economies have tended to be more risk-averse, downside-protection, savings-net-oriented than the U.S. economy. Why?
Perhaps in part because European economies spent most of the 20th Century either collapsing or rebuilding from two world wars, both of which completely wiped out the life savings of tens of millions of residents. America paid a human price in combat, but the wars were an economic boon.
Compare that to Germany and Japan in the years following 1945, when a full-blown humanitarian crisis developed. At the end of the war German farms only produced enough food to provide its citizens with 1,000 calories a day.
Part of Japan’s current demographic decline is due to a cultural preference for small families, which started when the government created policies and incentives to reduce births as the country teetered on famine in the late 1940s. You can’t expect countries whose experiences are that divergent from our own to have similar views about economic and social policies.
And this goes beyond economics.
There are theories that big wars tend to happen 20-40 years apart because that’s the amount of time it takes to cycle through a new generation of voters, politicians, and generals who aren’t scarred by the last war. Other political trends – social rights, economic theories, budget priorities – follow a similar path.
Whether you agree with her or not, Alexandria Ocasio-Cortez’s response to Joe Lieberman’s jab that she’s not the future of the party – “New party, who dis?” – echoes a trend that’s been followed for centuries. JFK’s inaugural address declared:
The torch has been passed to a new generation of Americans – born in this century, tempered by war, disciplined by a hard and bitter peace, proud of our ancient heritage – and unwilling to witness or permit the slow undoing of those human rights to which this nation has always been committed.
The Civil Rights Act – started by Kennedy, finished by Johnson – is an example of something that would have been impossible in one generation but was doable in another generation who grew up with different experiences and views than their parents.
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