One-quarter of Medicare spending goes to patients in the last six months of their life.
Politicians point out how wasteful this is. Budget analysts show how much could be saved by cutting this waste. One group you don't hear a lot of complaints from is doctors. There's a reason for this, as surgeon and author Atul Gawande once wrote:
"Analysts often note how ridiculous it is that we spend more than a quarter of public health care dollars on the last six months of life. Perhaps we could spare this fruitless spending — if only we knew when people's last six months would be."
The biggest problem when analyzing the past is that you know how the story ends. That makes it impossible to put yourself in other people's shoes and understand what they were thinking or feeling when they made decisions.
This is also true in investing, where most of what we study is the intersection of the past and emotional decisions.
We can look at the past and see that when P/E ratios are low, future stock returns tend to be high. Now we have a strategy backed up by data: Buy stocks when valuations are low. It seems easy enough! And it makes it easy to ridicule past investors for abandoning stocks at the wrong time, just as future returns are about to rise. Why did those idiots sell in 2009 when valuations were so low? Didn't they know you should buy cheap stocks? Look at how silly and misguided they were.
Easy to slip
I fall for this bias all the time. The flaw, of course, is that no one in 2009 knew stocks were bottoming. No one knew if a 50 percent drop was about to turn into an 80 percent drop. Among the range of possible outcomes, the U.S. economy's performance since 2009 is among the most optimistic scenarios a reasonable person could have predicted. I'd call it the top 10 percent of possible outcomes. But we rarely think like that today. We consider it the normal outcome, because it's what happened, and a simple mental roadmap of "normal" is a list of things that actually happened. Since we consider it normal, we think it must have been easy to predict.
So of course we now shake our heads at how investors panicked in 2009. And we should. But it's impossible to remember how scary — rationally scary — 2009 was, now that we know how the story ends. I really think it's impossible, no matter how hard you try. If you've never seen the movie, start with the final scene of "Planet of the Apes" and see if you can watch the rest of the film with an open, curious mind. You can't. No one can willfully un-remember what they know.
Whenever you're looking ahead, it seems like there are a million reasonable scenarios that could happen, because there usually are. When we're looking backwards, knowing the actual outcome instantly makes us forget how differently things could have played out.
Every time I watch a video of V-J Day in 1945, when World War II ended, I think, "Those people must be so excited. The war is over and they're about to enjoy the most prosperous three decades in world history." But they didn't know that. They were scared witless about the Soviets and the prospect of falling back into the Great Depression.
Assuming the risk
Applied to investing, there's a risk when looking at past data and assuming you'll have the courage to do the right thing in the future. Since you can no longer accurately remember how you felt in 2009, you'll probably misjudge how you'll feel in a similar future scenario. If stocks fall 50 percent again, you may not view it as another 2009 bottom. You'll wonder if we're headed for another 1933, or another 1990s Japan. And you may be right. Courage in the face of uncertainty is tough. It's why there are more people who quote Warren Buffett's "Be greedy when others are fearful" line than there are people worth $65 billion.
What can you do about it? Two things may help:
• The most important part of an investing strategy is your ability to stick with it. A subpar investing strategy that you can stick with and apply consistently will nearly always outperform a brilliant strategy you give up on. Your final investing results probably won't be determined by whether you currently use a strategy that historically delivers an extra 50 basis points of return. What will matter is whether you had the disposition to stick with investing, however you chose to do it, through thick and thin.
• As Benjamin Graham once said, "The purpose of the margin of safety is to render the forecast unnecessary." Those are probably the best 13 investing words ever written. Picture the most reasonable worst-case scenario. If you can survive it financially, forecasting the next bear market or the next recession — or in Gawande's world, the final six months of life — becomes less relevant.