Everyone knew that the market had to crash around 2008. With real estate appreciating in value the way it was, even an idiot could see disaster coming, right?
Not so fast. A quick look at the headlines in early 2008 on Google's Archives Search will paint a different picture.
For instance, in January of that year, a professional real estate organization predicted that the Florida housing market had hit rock-bottom in the spring of 2007, and was "expected to begin to recover during the next several years."
Instead, 2008 saw single-family home sales in the state drop 4%, while the average selling price was 20% lower.
In essence, almost nobody saw the crash coming. It would have been impossible for the market to drop almost 50% in a six-month time frame -- as it did between September 2008 and March 2009 -- if there were factors that were "obviously" at play.
And yet, we continue to think we can predict the future.
The hindsight bias
I've been investigating lots of different biases that can ruin our investment returns. What we're talking about today is the hindsight bias: our tendency to look at past events as though they were imminently predictable.
I've mentioned before how the recency bias ruined an investment I made in Netflix (NFLX +1.13%). But the company is also the perfect example of hindsight biases at work.
Though much of the company's 60% decline in 2011 was due to the shift from mail-order DVDs to the high-cost content acquisition of streaming, CEO Reed Hastings didn't help out his company's stock one bit. His cold notice to subscribers that prices were increasing markedly turned his company from a favorite to a national foe overnight. I was so shocked that I even engaged in a dialogue with him about it.
Though I -- and many other investors who got burned -- would like to believe that there were signs everywhere of Hastings' disregard for his customers, it's mostly hogwash.
There's no way I could've seen it coming.
What you can do
Though thinking you could've predicted the past is silly, it's relatively harmless. It's when we take this belief and apply it to the future that we get in trouble.
That's why, according to Michael J. Mauboussin, chief investment strategist at Legg Mason Capital Management and adjunct professor of finance at the Columbia Business School, it's so important to keep an investing journal.
"When you've got a decision-making journal, it gives you accurate and honest feedback of what you were thinking at that time," Mauboussin says.
If you're thinking of investing in Netflix now, after it's wowed Wall Street , write down your reasons for doing so.
