Confirmation Bias and FOMO

Jeff’s Random Words

I am not an investing expert (insert insult from Jason here). However, I also wouldn’t consider myself a beginner anymore. One area in which I feel that I am particularly beyond the beginner phase is the psychological aspects of investing. Investing behavior. Investing mindset. Whatever you want to call it.

This is partly because I have been investing for more than 20 years through my retirement accounts, so I have seen a few things (9/11, the Great Financial Crisis, COVID, etc.). And it’s also partly because I’m in my mid-40s. I do think some wisdom comes with age, and I am certainly less impulsive now than I was in my 20s.

And that brings us to last week. One of the stocks I have been looking more deeply into over the last few weeks is QuantumScape (QS), a solid-state battery company. QuantumScape has the potential to meaningfully change the electric vehicle market by replacing the existing Lithium Ion batteries with solid-state batteries that have longer ranges, faster charging times, and can be operated more safely. As someone who believes the future of cars is electric vehicles, I find this company and its technology fascinating.

I’ve known about QuantumScape for some time thanks to Jason, who has owned it for a while. There are also several videos about the company on our YouTube channel. But last week I was getting closer to a decision on whether I wanted to add it to my portfolio. It would be a small position because the technology is still not proven, but I see the risk/reward as compelling. 

Then this happened:

Just as I was considering buying a position, the damn stock jumped 43% on good news about one of its batteries being tested by Volkswagon. 

Then it happened. Fear of Missing Out (FOMO). I was mad at myself for not buying it earlier in the week. I texted some not-suitable-for-publication words to Jason and we had a good laugh. But here’s the thing, if I am being honest, I wasn’t READY to buy the stock yet. I hadn’t done all my research, I wasn’t REALLY close to buying it. I was just getting closer. Seeing that big jump changed the way I remembered how I felt just 12 hours earlier. And if I am being honest, had the stock dropped 43% that day, I would have been proud of myself for “sticking to my process” and not rushing into a buying decision.

There’s one more point I want to make. When and if I do end up buying QuantumScape, I need to go into that purchase eyes wide open to the fact that there will likely be several days of large jumps and dramatic drops. This is a pre-revenue company trying to prove the efficacy of a new technology. Big stock moves are part of the deal. QuantumScape has a beta of 4.9. Put simply, if the market goes up 1%, I can expect QuantumScape to go up close to 5%. And it's the same on the downside as well. 

If I have made any progress over the 4 years I have been an individual stock investor it is that while I can’t stop feeling the FOMO, I am at least aware that I am feeling it and I (usually) can resist the urge to act on it.

Jeff

Jason’s Random Words

I want to share a little bit more about QuantumScape, both what happened with the stock this week and what happened with the business. And maybe the most valuable thing I can share is some observations of the investing public, distilled down to my interactions with some of the viewers. 

I've made quite a few videos looking at the company over the past year and a half. Some with Tyler Crowe, and a few solo efforts. This week, I broke down the news that sent its shares surging almost 50% higher at one point. If you want a more detailed explanation, watch the video, but the short version is VW – QuantumScape's biggest business partner and a financial backer – confirmed something that QuantumScape told us almost three months ago and the market absolutely went bananas. 

Part of it was likely short sellers reducing or closing their short positions. The mechanism to close a short is to buy shares, and with 11% of shares sold short, this could be a large portion of the buying action that drove the stock price higher. As an aside, the 8% decline in shares the second day after the news somewhat confirms this; other investors probably opened short positions based on the huge pop, once they processed the news that sent the stock higher. 

So what exactly was the news? A pretty small bit of positive data that confirmed something we already had been told. The company had a single test sample perform extremely well. 

And while Jeff wrote about FOMO, let me tell you, confirmation bias is extremely powerful. I had a number of commenters on the video insisting that QuantumScape was a no-risk investment and that this confirmed their technology was to (paraphrasing here) dominate. One even said "You think you're smart by playing the cautious card…" and then listed a litany of things that support their bullish thesis. 

Here's the problem with thinking – and investing – that way. You can be right about every single part of a bull thesis, and then just be wrong about one other thing and it can completely undermine things. I've talked about GT Advanced Technologies before, a company that had developed some of the best equipment in the world that made synthetic sapphire, an ultra-tough, and very clear, material that was seeing huge demand from smartphone makers on top of their core solar business. 

That company filed for bankruptcy seemingly overnight when it got in over its head on a contract with Apple (AAPL) it couldn't deliver on. I don't think anyone saw that coming. I mean, this was a profitable company with a manageable balance sheet, in growth mode! 

Risk is what's left over after accounting for everything you know. And for a company like QuantumScape, we still don't know if they can actually mass produce solid-state batteries. Much less whether they will be able to do it at a cost that competes with existing technologies, and leaves room for a nice profit. 

We don't know because the company hasn't done it. What we do know could fit on a single sheet of paper. 

• They have what looks like, in a lab, a very, very good battery technology. 

• They have developed some processes and equipment that they say can manufacture them. Specifically do the hard part that has kept anyone from manufacturing a solid-state battery so far. 

• Third-party partners have confirmed some positive tests.

What we don't know could fill up a phone book. But it can be distilled down to not knowing if they can actually manufacture batteries at scale that are actually better and/or cheaper than what's out there. 

What's the lesson here? For me, it's how important it is to temper the bullish me who seeks out confirming data with an eyes-wide-open look at the risks I can see and then builds financial buffers to help reduce the potential harm of the risks I can't account for. 

I own a small amount of QuantumScape, and it lives in the speculative corner of my portfolio. I am willing to risk some small portion of my portfolio every year to potentially binary outcome bets like QuantumScape. But I keep it small enough that even if none of them work out, I'll still reach my financial goals. Sometimes the companies graduate to proven businesses. Sometimes they fail to deliver and I sell at a loss. Occasionally they completely fail and go to zero. 

Back to confirmation bias. It's strong. The gravitational pull of a believable bull thesis can pull a portfolio apart. For me, building some frameworks around position sizing and how much of my total capital I'm willing to risk on these bets is just one of the ways I avoid letting a series of wonderful ideas wipe out my wealth. 

Jason