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In a recent blog, I referenced the statement “This time it’s different,” and listed all the problems associated with believing this a true statement. In my blog, I stated that I had lived through seven bull and bear market cycles. In each stock market cycle, someone announces “This time it’s different.”
The statement itself is true because each time and situation is different. The stock market reacts differently to economic conditions, inflation, interest rates, and unanticipated world events. The problem is not the statement itself but the context surrounding the statement. The context surrounding the statement would indicate that circumstances surrounding this event will cause an outcome different from previous outcomes and that this outcome will benefit the investor. For more context, see THIS TIME IT’S DIFFERENT.
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These types of statements are called Logical Fallacies. More specifically, the phrase “this time it’s different” is classified as a form of “over-extrapolation” or “hasty generalization” fallacy, where someone assumes a current situation is fundamentally different from past similar situations, ignoring historical patterns and trends, often leading to overly optimistic predictions.
The problems start when uninformed or unaware investors believe these fallacies and believe them to be true. Lack of awareness can create significant problems, which cost the investor time and money. Fallacies can usually be diffused or avoided by knowing and recognizing them.
Most logical fallacies can be identified and disproven through reasoning. A subjective argument is an argument that can be disproven factually. For a statement to be considered a logical fallacy, it must be logically incorrect or patently deceptive.
Logical fallacies have been around for a long time. The first written text about logical fallacy occurred around the sixth century BC as part of Hindu philosophy.
Aristotle, the Greek philosopher, also wrote about fallacies. He divided fallacies into two general headings: verbal and material fallacies. Aristotle wrote that a verbal fallacy uses ambiguous or incorrect language, whereas a material fallacy involves faulty or flawed reasoning.
If you’ve been around long enough, you’ve encountered logical fallacies in conversations and social media. But, logical fallacies are found in academic writing where the author has to defend his position or persuade the reader. People may make logically inconsistent statements because they don’t fully consider their reasoning. However, there are situations where the person willfully intends to mislead someone else with flawed logic, attempting to dissuade or discredit the other’s position.
Investors need to understand common fallacies. Here are some of the most common logical fallacies.
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Common Logical Fallacies
- Slippery Slope– the statement “this time it’s different” would be an example of a slippery slope type of logical fallacy. A slippery slope statement claims a specific event will follow a series of preliminary events, even with little or no supporting evidence.
- Hasty Generalization– “This time it’s different” could also be termed a hasty generalization. Hasty generalizations use one or two examples rather than relying on extensive research. In the case of the statement “this time it’s different,” more exhaustive research would indicate that the outcome of any Bull market will eventually be a Bear market.
- Red Herring– a red herring is a form of verbal sleight-of-hand. A Red Herring fallacy misdirects discussion by introducing an irrelevant fact. An example would be an Advisor discussing a Retirement Plan who switches the conversation mid-stream to begin discussing travel in retirement. This verbal sleight-of-hand directs the conversation away from questioning fees or asking difficult follow-up questions.
- Sunk Cost– the decision to continue down a path relies on the amount of time and resources already dedicated. In finance, a good example would be the stock buying technique called “Bottom Fishing” where the investor buys additional shares of a continually declining stock. The philosophy here is that if a stock is a good buy at $10 per share, it’s a great buy at four dollars per share. This investor doesn’t want to admit that his initial purchase was ill-advised, so he doubles down and buys more stock as the price declines.
- Causal Fallacy– The causal fallacy is founded on an incorrect assumption that two unrelated items or events have affected each other. The person believes the action of one creates a specific result for the other. With investors, the big “tell” here would be a lucky charm or an event that prompts an action. For example, an investor finds a penny facing head up on the street and assumes this means that his luck is good and he should buy a particular stock or engage in a particular action.
- Appeal to Authority– regardless of credentials, the person presenting the argument claims to be an authority. This action relates to an expert being “someone who lives over fifty miles away and carries a briefcase.” An investing example would be someone who has several financial designations and claims to be an expert in some area of finance, regardless of actual expertise or experience.
- Ad Hominem– this fallacy discounts others’ arguments based on personality traits or factors. An example would be to declare someone unable to understand another’s position because of hair color, body size, weight, height, posture, facial expressions, etc.
- Bandwagon– also known as “following the herd.” This fallacy is a personal favorite and has cost investors untold money. The problem with this fallacy is that the herd is rarely correct. Blindly following the herd leads to buying at near-market highs because the herd is optimistic and selling at near-market lows. After all, the herd is scared and pessimistic. This action is the opposite of the money-making market strategy of buying low and selling high. An investor must oppose the herd mentality to maximize success.
- Burden of Proof– this fallacy uses reverse thinking by stating something must be true if it’s not proven false or false if it’s not proven to be true. An investing example would be stating that a particular sector or stock can’t continue to rise because of its recent stellar performance. The reverse of this example would be to say that a stock or sector can’t decline because it’s been a “rocket ship” and can only go higher.
- Equivocation– unclear statements created by using multiple meanings of a statement or simply using misleading phrases. The following statement would be a good example for investors: To build wealth, investors must hold good companies, Blue Chip stocks, the S&P 500 index, Large-cap stocks, and a mix of dividend-paying stocks. Using a mixture of investments provides’ diversification and asset allocation to provide maximum portfolio performance and return over a broad sector.
- Straw Man– a straw man argument uses an exaggerated or misleading view of the opposing argument to make it easier to attack and discredit. An example used in finance would be the following discussion: *Investor A: “We should diversify our portfolio by investing in a mix of stocks and bonds to mitigate risk.” *Investor B (Straw Man fallacy): “So, you think we should just throw all our money into low-return bonds and completely ignore the potential for higher gains with stocks? That’s a terrible idea! Investor B (Straw Man) exaggerates the return potential of an all-stock portfolio while ignoring the increased risk. The straw man ignores the wisdom of diversification to promote his position.
- False Dilemma– by claiming only two available extreme and opposing solutions are available, it becomes easier to ignore other less extreme solutions. A finance-related example would be the two options of selling all stocks and moving 100% into a cash position versus being in a 100% stock position. These opposed positions would exclude all other portfolio combinations not on either end of this extreme.
- Circular Argument– A circular argument uses the same statement at the beginning and the end of an argument. An example in finance would be the argument that having only one fund in a portfolio would simplify portfolio management because having more than one fund in a portfolio increases complexity.
- Appeal to Pity– excuses the lack of facts by appealing emotionally to the listener. A financial-related example would be an advisor telling an investor he knows their portfolio trailed the corresponding index but has not been feeling well and had marital problems. These have nothing to do with his poor job performance but appeal emotionally to the disadvantaged investor.
- Rebuttal Fallacy– the response to a claim criticizes the opposition rather than responding to the argument. In finance, an example would be an advisor who claims the investor is not intelligent enough to understand the advisor’s investing philosophy instead of speaking about his portfolio performance.
- Texas Sharpshooter– uses limited data to support a position rather than a broad information base. A finance example would use economic data from one source versus combining many different sources.
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One must consider the validity of the facts presented when discussing a topic, receiving help, or making recommendations. This is especially true when that person is trying to convince you to assume a particular financial position, or to purchase a financial product. Using logical fallacies helps support a weak position or argument. Think about the facts that the person is presenting. Do the facts make logical sense? If facts are challenged and argued can the position be defended by providing additional facts and information?
A proven strategy would be to use the “challenge and verify” technique used commonly in technology today. What does challenge and verify mean? “Challenge and verify” means to present a question or task that requires a response to confirm the authenticity or legitimacy of someone or something, essentially acting as a test to prove identity or correctness; “challenge” is the act of presenting the test, while “verify” is the process of checking the response to ensure it is accurate and valid.
By challenging and verifying the information presented, not only does the presenter have to defend their current position, but they must defend their position with valid and logical information.
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Final Thoughts
There are several statements I’ve made in blogs and podcasts that I will repeat here because understanding and using these principles will save time and money while avoiding emotional distress.
- Knowledge is power– Having a solid knowledge base helps to avoid being misled by illogical or incorrect statements. It’s much easier to identify common fallacies and challenge the information when you have an extensive knowledge base.
- Advisors are people too– All advisors wrestle with personal and financial conflicts while advising clients. Advisors have financial obligations and families to feed like everyone else. Most advisors are honest and hard-working people. But, even advisors who work in a fiduciary capacity may not be required to act as fiduciaries in every financial transaction completed on your behalf. There is always conflict with what is best for the client versus what is best for the advisor.
- No one will care more about you than you will care about you– regardless of what anyone tells you, especially if that someone is a financial advisor or insurance agent, no one will care more about you and your financial well-being than you will care. Therefore, it is critically important that you shield yourself with knowledge, skepticism, and extensive evaluation of all information presented before making financial decisions. Some financial decisions can be irreversible or financially unpalatable once made. It is much better to step back and evaluate financial decisions before proceeding, especially if decisions are irreversible.
- Seek wisdom from unbiased sources– the most valuable knowledge you will gain will come from people and sources that are valid and unbiased. I would list the RETIRING WITH ENOUGH blog and podcast as one of these trusted sources. Although I cannot guarantee the complete accuracy of all the information provided, complete honesty and accuracy are always my goal. Both the blog and podcast are nonprofit. No donations or stipends are accepted. Both the blog and the podcast are non-subscription. There are no paywalls, and I don’t accept advertising with advertising’s associated revenue. Because of my operating model, There is no pressure to provide information a certain way or with a certain tilt.
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