Markets and Economy Managing the cognitive dissonance of long-term investing

Life entails a certain level of cognitive dissonance. It’s the discomfort you feel when you hold two conflicting beliefs at the same time — and the way your brain resolves that discomfort by rationalizing behavior.

I wrote this one day before my 50th birthday, a milestone that has me rationalizing behavior that conflicts with what I know to be true.

    Belief A: Alcohol is bad for my health.

    Belief B: I’m going to drink alcohol on my birthday.

The rationalization is simple. It’s for one night. What matters most to my long-term health are decisions made over decades, not over single nights.

Investing presents a similar tension, but with far higher stakes.

    Belief A: Trying to time the market is bad for my investing health.

    Belief B: Reducing exposure until risks subside will make me feel safer.

The rationalization many investors often reach is confidence in their own intuition. “I’ll know when to get back in. I’ll recognize the signal. I’ll avoid the worst of the decline and still participate fully in the recovery.”

The difference between these two examples is stark. In the first case, I may wake up tired and dehydrated. In the second, investors may permanently erode my long-term investment returns. The cost of resolving that discomfort is much higher.

Market movements in an uncertain world

Markets rarely reward those who wait for certainty. By the time risks feel resolved, prices have often already adjusted. For the most part, markets are forward-looking and probabilistic versus reactive and emotional.

Recent events provide a clear example. Despite elevated geopolitical risk, markets have behaved as though a worst-case outcome was unlikely. The S&P 500 Index bottomed on March 30 following a peak-to-trough decline of “only” 9.01%.¹ They appeared to be looking through the conflict in the Middle East, anticipating a relatively short duration and limited economic spillovers.

So, when Iran announced on Friday that the Strait of Hormuz would remain open during the ceasefire, it felt like confirmation rather than surprise.² Oil prices, which had been primarily falling since the end of March, plunged.³ The S&P 500 Index, which had been rallying for most of the month, closed at an all-time high.⁴ Small-cap and emerging market stocks extended gains that began in mid-March.⁵ Credit spreads tightened further, and are now lower than the days before the conflict began.⁶

Forward-looking versus reactive

Markets being forward-looking and probabilistic for the most part, rather than reactive and emotional, is an important distinction. Waiting on the sidelines for Friday’s announcement about the opening of the Strait of Hormuz may not have been rewarded. A lot of positive price action came before the good news and continued Friday, before cautious investors were likely able to respond to it. Weekend events resulted in the Strait being closed again, but the point still holds. While there may be near-term volatility as a result, the market may still trade as if a negotiated deal is forthcoming. 

Importantly, many fundamentals appeared to reinforce this market resilience. Corporate earnings were off to a solid start, particularly among large banks.⁷ Jobless claims remained low.⁸ Regional purchasing manager surveys have been moving higher, suggesting firmer manufacturing momentum.⁹ Growth in the United Kingdom has exceeded expectations.¹⁰ Growth in China has also come in better than the most pessimistic forecasts.¹¹

Many investors tend to stay invested because they accept cognitive dissonance as part of the process. They recognize that their time horizon is longer than the lifespan of any single conflict. They think in probabilities rather than certainties. Much like decisions in life, investment decisions are best judged over decades, not nights.