Thanks to the field of inquiry known as behavioral finance, we know of a number of instincts that can steer us wrong as investors. One of the big ones is recency, in which we tend to lend more decision-making weight to recent turmoil than to expected long-term outcomes.
It’s one thing to know about recency in theory. It’s quite another to recognize when it’s happening to you. This summer’s Brexit referendum serves as a great example of recency, so let’s take a closer look of that in action.
Immediately after the narrow passage of the June 23rd Brexit referendum, even the most stalwart investor braced for the worst as media outlets such as BBC News, Reuters and Bloomberg reported that the British pound had sunk 8%, European stocks had suffered the worst sell-off since 2008, the Japanese Nikkei Index had posted a one-day drop of 7.9% and our own S&P 500 Index had fallen 3.6%.
And that was all just on Friday, June 24th, based on the immediate, reactionary trading to the voting results – i.e., recency. What was Monday to bring?
At the time, we reached out to our clients to caution them to avoid succumbing to recency, reminding them:
If you’re having your doubts [about remaining exposed to market risks], consider your current feelings an important and valuable insight about yourself, but please, please sit tight for now. Do give us a call right away, though, and we’ll explore how best to ratchet down your investment risk sensibly and deliberately.
At least the weekend gave everyone a couple of days to cool off before anyone could make any more sudden moves. Maybe that helped. Maybe the results would have been the same either way. For whatever reason, most markets stabilized surprisingly quickly, despite the impact an actual Brexit might still have on the global economy.
By July, the media was back to busily reporting multiple sorts of record highs for U.S. stock indices such as the S&P 500. According to one CNBC July 22 report: “Friday’s eurozone data and recent U.S. data are lifting investor sentiment and U.S. markets, said Art Hogan, chief market strategist at Wunderlich Securities.”
Why had “investor sentiment” changed? Again, we would assume that was nothing more than fleeting recency at play. As we commented in a July client communication:
Almost everywhere we turn, we’re seeing headlines referring to the “post-Brexit” environment. … Current headlines really should refer to the “post-Brexit referendum,” because only the referendum is done. In it, a narrow majority of U.K. voters called for a disunion from the EU, but any actual Brexit is likely to be playing out for years to come. Only then will we be truly “post-Brexit.”
What Should You Be Doing?
This is not to say we’re ignoring unfolding news about how Brexit politics continue to play out (not to mention our own looming presidential elections). The news is important to us in all sorts of ways, so we’re glad the media continues to report on it. We’re also glad that global markets seem to be alive and relatively well this summer … at least so far.
But the lesson about recency is as follows: While the outcome of the Brexit referendum was new and different, its impact on the market is old hat. These are the sorts of events you want to bear in mind when you set up your long-term investment portfolio to begin with.
Using global diversification, effective asset allocation and careful cost management, your goal as an investor has been – and remains – exposing your portfolio to the market risks and expected returns you need to pursue your financial goals, while minimizing over-concentration in any one holding. That way, you are best positioned to avoid bearing the “Ground Zero” worst of it when market crises do occur.
If you’ve already built your investment portfolio for withstanding heightened market risk when it occurs, you can congratulate yourself for having already prepared as best you’re able. If your portfolio remains the result of continued reactions to current events, there’s no time to waste in forming a plan to guide the way past both the fortunate and frightening news. That’s the best strategy for looking past recency, and keeping your eyes on the long haul required for building lasting personal wealth.