In 2011 the Japanese city of Miyako was destroyed by the Tsunami created by the Tōhoku earthquake. Sadly, this was not the first time a Tsunami destroyed the city.
In 1933 Miyako was destroyed by another Earthquake and Tsunami. 42% of the city’s population died as a result.
Surrounding Miyako and the Iwate Prefecture Coastline are many stone markers, some centuries old, indicating the high water marks from previous Tsunamis. One marker inscribed in Kanji states1,
High dwellings are the peace and harmony of our descendants. Remember the calamity of the great tsunamis. Do not build below this point.
It is a warning to future generations that are thinking about resettling the port valley. “Avoid our suffering. Please keep to higher ground”.
It was ignored.
Why do we, humans, in spite of all the lessons from the past keep making the same mistakes? Repeating avoidable tragic disasters again and again?
Politics and economics play a role. The land above the stone markers is in high demand and costs more. Those without the same resources but creep slowly back down into the valley where land is more affordable.
Our psychological biases also play an important part too.
Psychological Factors
Myopia Bias
We treat rewards that are immediately present far more favorably than rewards that are well into the future. We focus more on our short-term actions than long-term ones. This makes it very hard to stick to behaviors that protect us from low-probability but high consequence events that could occur sometime in the future. Like paying for flood or earthquake insurance.
Amnesia Bias
Memories of pain are short-term and easily replaced by more positive memories. This quirk helps us overcome short-term setbacks and to learn. We’ll never forget a disaster but we will forget the pain. Forgetting helps us in the short-term but harms us when we need long memories, sometimes multi-generational, to avoid repeating the trauma from a natural disaster.
Optimism Bias
We tend to believe we aren’t as susceptible to harm as other people. Do you have an emergency supply of food, water, and other essentials in case of a destructive earthquake or wildfire? How many people in hurricane prone areas like Florida stay home to ride out a hurricane instead of heeding evacuation orders?
Inertia
When we have to make tough decisions based on an uncertain future our brains get stuck in a state of “analysis paralysis”. In this state, we fall back on the default option. The default option is usually doing nothing.
Herding
A lot of what we do is based on social clues from others. We look to the group to determine the appropriate action. If our neighbors are not preparing for a disaster or evacuating we tend to do what they are doing. People living in high potential flood areas will buy or not buy flood insurance based on if their neighbor has bought it or not.
Bear Markets Are Like Natural Disasters
These same psychological biases are part of the reason for the boom-bust cycles in the stock market and why the average investor get hurts repeatedly.
When stocks are going up we forget that they will go down. When we’re making money it feels good and we forget the psychological pain market declines cause.
During bull markets it is easy to make money and how easily we make money makes us think we’re smarter than we are. Of course we’ll be able to avoid the next bear market, because we are investing so smartly now.
If our friends and family are buying the current hot stock then we will too even if we don’t really understand how the company makes money
Once we’re invested we’re faced with a lot of unknowable decisions. Our rational thinking system is overwhelmed so it relies on its default answer. Do nothing.
We can never fully insulate ourselves from bad decisions or the next bear market. Especially since we don’t know when they will happen. But like preparing for a natural disaster, we can set-up systems and plans to be prepared and to help lessen future pain.
Rebalancing
Establishing a target asset allocation is the most crucial investment decision you'll make. This allocation should reflect your unique risk tolerance, life stage, and financial goals. With a personalized allocation strategy, you create a framework that helps you navigate market volatility with confidence rather than fear.
By setting clear percentage targets for different asset classes in your portfolio, you establish guideposts that signal when it's time to buy or sell. This systematic approach creates a disciplined investment strategy.
Consider a simple allocation strategy of 50% stocks and 50% fixed income—a moderate investment approach. If stocks outperform fixed income and your portfolio shifts to 60% stocks and 40% fixed income, you would sell 10% of stocks (taking profits) and buy 10% of fixed income. This rebalancing maintains alignment with your predetermined long-term objectives.
It can feel uncomfortable to move money out of a rising asset into an "underperforming" one. However, when these trends inevitably reverse, you'll appreciate your discipline in consistently rebalancing.
Maximum Position Size Rules
Maximum position sizing is similar to rebalancing but focuses on individual holdings rather than entire asset classes. This approach establishes a predetermined maximum percentage that any single position can occupy in your portfolio.
When a position grows beyond this threshold, the rule automatically triggers a partial sale—trimming the position back to its target weight.
This system allows you to remain invested in companies you believe in while preventing any single holding from dominating your portfolio. The rule also removes emotional decision-making from the equation. It's psychologically difficult to sell shares of a rising stock when it feels like the upward trend will continue indefinitely. Yet inevitably, though unpredictably, the stock will decline. An oversized position can significantly damage your overall portfolio when this happens. By following a maximum position size rule, you systematically take profits during upswings, which helps limit potential damage during subsequent downturns.
Creating systems to avoid our psychological biases and emotional decisions when managing our money is equivalent to the stone tsunami markers in Japan. However, we must still make the active decision to heed their advice.
Story is from the book “The Ostrich Paradox: Why We underprepared for Disasters”