Beware of this bias – it could cost you

Have you ever been overwhelmed by the choices in a restaurant’s wine menu – and just decided on the house wine?

Or, when you buy the latest mobile phone, do you just accept the factory default settings and not even bother changing the ringtone?

Do you buy cornflakes because you’re overwhelmed in the supermarket?

It’s not just “analysis paralysis”. Most people are happy to stick with the standard options. Even when we have several choices, we go with the default choice because it’s easier and more comfortable.

When a small town in Germany was forced to relocate due to a nearby mining project, the citizens were given the chance to vote on a variety of plans for the new town. But, instead of seizing the opportunity to make the town’s layout more efficient, the citizens voted for the plan that most closely resembled the old town – even though it was divided by a large serpentine.

Most people like to stick with what they know and are anxious about making big changes or taking on new risks – even if the change would be good for us. This is called “default bias”.

It’s the offspring of two other biases: status quo bias and loss aversion; keeping things the same (status quo) is convenient, and is often the easy path. And for most people, the pain of losing is greater than the joy that comes from winning – which encourages them to keep things the same.

Put these together, and our brains often tell us it’s just easier to keep things the same and avoid any potential pain that might come from changing things. For investors, default bias can stop us from making changes to our portfolio or strategy because it’s too inconvenient or it makes us feel uncomfortable. And that can be hugely damaging – and costly.

It happened with the internet

Where can default bias hurt you? In many ways…

In the early 1990s, the internet was just starting to go mainstream. And many otherwise smart folks were convinced it was just a fad.

Here’s a quote from US astronomer Clifford Stroll in 1995:

“Visionaries see a future of telecommuting workers, interactive libraries and multimedia classrooms. They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems. And the freedom of digital networks will make government more democratic. Baloney.”

Telecommunications expert Waring Partridge had this to say: “Most things that succeed don’t require retraining 250 million people.”

These people – and untold hundreds of millions more – fell victim to default bias. They believed in what they knew and were anxious about making big changes or taking on new risks.

Investors who similarly choose to ignore the internet missed out on big gains as the Nasdaq – which is home to many tech stocks – rose 400% from 1995 to 2000.

I think that we’re seeing something very similar happen with bitcoin and cryptocurrencies today – it’s a replay of the status quo bias. And again, lots of people are missing out. Most people don’t understand cryptocurrencies.

Anyone who claims bitcoin isn’t “real” or it will “close” doesn’t understand the cryptocurrency at all.

As we’ve written before, bitcoin can be moved around (far more easily than traditional currencies), used to buy goods and services and it has scarcity. Only 21 million bitcoin will ever be mined. And over 17 million have already been mined.

As for the concern that bitcoin is purely “digital”, it’s worth remembering that more than 90% of all money that exists today around the world is not physical (ie, not notes or coins).

And as we’ve written before, bitcoin can’t be “closed”. It’s not an overleveraged credit derivative fund. It’s a highly secure distributed blockchain running on a global network of computers. Bitcoin is a cryptographically secure medium of exchanging value over a computer network. It’s not “fraud”, nor a “real currency”.

Every now and then something truly different and new comes along. And if you’re willing to go against your default bias, you could make a fortune.

That doesn’t mean bitcoin won’t be volatile.

Of course, after the dotcom boom, there was an epic dotcom bust. And cryptocurrencies have of course experienced a lot of rallies and very steep corrections – perhaps we’ll see one soon.

Bitcoin is just over a decade old and has already seen a dozen price rallies of nearly 100% – and just as many selloffs.

But the crypto revolution is just beginning, and there are fortunes to be made.

Even though there’s plenty of hype around it, the level of general public participation is still low. And you still need to familiarise yourself with a new asset class, which takes some effort.

That’s changing of course. At the time of writing, bitcoin is at an all-time high of nearly £38,000 – up over 400% since this time last year. That in itself is impressive and proof of crypto’s growing appeal.

But even more interesting is what’s driving the current rally. Just as our resident crypto expert Sam Volkering predicted, bitcoin is catching the attention of big money investors.

JP Morgan and Goldman Sachs have recently begun to pay close attention to the cryptocurrency, and are open to embracing the asset. Tesla lit a fire under the price when it announced that it had bought $1.5 billion worth of bitcoin and plans to accept the currency as payment.

This doesn’t just help explain the rise in price. It’s also of the growing legitimacy of bitcoin in the eyes of “traditional” money.

But bitcoin (and, even more so, other cryptocurrencies) is an asymmetric bet… if it falls or even goes to zero, your loss is small (assuming you’ve put in only what you can afford to lose). But if over the next few years it continues go up, then gains of 10 to 50 times are entirely possible… and even bigger gains lie outside of bitcoin in the cryptocurrency space.

In short, cryptos are here to stay. You can familiarise yourself with them – and with the process of buying, trading and storing them… or you can try to ignore them.

But where was the internet in 1994? And where is it today?

Don’t be left behind.

All the best,

Nathan Tipping
Research Analyst, Southbank Investment Research

Category: Investing in Bitcoin

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