CHIMAMANDA ADICHIE coined the term “single story” in 2009. A novelist and a native of Nigeria, Adichie first came to the U.S. to attend college. Almost immediately, she was struck by the one-dimensional lens through which many saw her. It started with her roommate.
Knowing that Adichie had just arrived in this country, her roommate—an American—asked how she was able to speak English so well. Adichie had to explain that English is Nigeria’s official language. Her roommate was further surprised when Adichie chose to listen to the music of Mariah Carey. Her roommate had expected her to prefer, as she put it, “tribal music.” In short, Adichie says, her roommate was making the mistake of operating with a single story.
This sort of thing is common and can trip up investors, too. Faced with a complicated world, our minds naturally try to cut through the noise by looking for patterns. We develop shorthand stories to quickly characterize investments and put them in mental boxes. Growing companies, for example, are “going to the moon,” while struggling companies are “doomed to failure.” Some markets are “the future,” while others are “disasters.” Simple stories tend to be binary.
When we oversimplify like this, however, we run two risks—false positives and false negatives—both of which can be costly. With false positives, the single story focuses on everything that’s attractive about an investment, while dismissing all of its risk factors. With false negatives, we do the opposite, writing off an investment as a dud without giving consideration to anything that’s positive.
In today’s market, the risk of single stories seems particularly high. That’s because markets are in the middle of what some have called an “everything rally.” Everything seems to be going up—growth stocks, value stocks, IPOs, SPACs, cryptocurrencies, even trading cards.
A few weeks ago, the focus was GameStop. But that was January’s story. Now other “shiny object” assets are going up. Consider the latest: dogecoin.
According to one of its creators, dogecoin wasn’t intended as an investment. Instead, it was initially created as a joke. But recently, it has gained traction, rising about 12-fold in this year’s first six weeks. Adding to dogecoin’s popularity: an endorsement from Elon Musk, who recently became the world’s wealthiest person after the value of his own company rose 700% last year. It’s beginning to feel a little bit like a hall of mirrors.
Of course, an everything rally can’t go on forever. It stands to reason that eventually some of these inflated assets will return to Earth, just as we saw with GameStop, while others will continue to prosper. How can you tell which will die and which will thrive? These kinds of highflying investments are like a Rorschach test—with their value in the eye of the beholder. That makes them unusually susceptible to single stories.
The solution? Work to gather the full story behind a prospective investment. Here’s the five-part framework I recommend:
1. Consider the obvious merits. This is the easiest aspect of an investment to evaluate. If you’re analyzing a stock, the company’s merits might include a unique product, increasing market share or a talented management team. You need to look at the company’s current earnings and ask how likely it is to continue delivering those results.
2. Consider the obvious risks. Each type of investment carries its own set of risks. For a technology stock, obvious risks might include signs of market saturation or a new competitor. For an energy company, an obvious risk would be low oil prices like we’ve seen in recent years. In the world of bonds, the big fear today is that interest rates might rise, perhaps significantly, if the government passes an outsized stimulus package. As in step No. 1, you can’t perfectly predict or quantify any of this. Still, the goal is to force yourself to think about the risks involved.
3. Consider what opportunities might lie below the surface. In this step, you want to go beyond the information that’s plainly visible. For example, if you’re looking at a consumer products company, ask yourself if it might be working on a new product line. Consider Apple. Before it introduced the iPhone, no one knew it was coming and it wasn’t factored into the share price.
In the world of bonds, there are opportunities, too: Interest rates could drop unexpectedly, as they did last year. Or a slowdown in the stock market could cause a rally in bonds. The reality is, there’s an infinite set of things that could happen, but there’s no need to conceive of every possible outcome. The objective here is just to recognize that, with an investment, there might be—and often is—more than meets the eye.
4. Consider what risks might lurk below the surface. Suppose you’re looking at an investment, and it appears great. Again, Apple is a good example. What could go wrong? The late Harvard professor Clayton Christensen argued that the biggest risk for successful companies is what he called the “innovator’s dilemma.” Companies become so focused on doing what they do well that they get caught flatfooted when a new competitor delivers a better mousetrap. As you think about risks, keep this in mind. An investment that looks perfect only looks that way because you can’t see what’s below the surface.
5. Keep in mind that, in most cases, investments aren’t necessarily “good” or “bad.” An investment that’s good for someone else might not be appropriate for you. Be wary of other people’s single stories.
A final note: As you evaluate an investment’s positives and negatives, be aware of the natural human tendency to put disproportionate weight on the negative. Four psychologists summed it up well in a 2001 study: “Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones.” As you consider both sides of a potential investment, try to correct for the fact that you will inevitably find it easier to scare yourself out of an investment than to talk yourself into it.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, he advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman and check out his earlier articles.