Don’t succumb to “Recency Bias” or other common investor mistakes made during volatile markets.
- Research shows that the more recent a jarring stock market, the more likely it is to distract investors from information that’s objective about their long-term investment goals.
- Put today’s environment into historical context. Look for tax management and rebalancing opportunities and take the financial news with a grain of salt.
- Don’t revise your strategy unless your investment objectives have changed. Good things rarely happen when plans are changed in the heat of battle.
The recent volatility in global stock markets world has shaken the resolve of many investors.Volatility often has the effect of disrupting the plans of investors in a variety of ways. One of the main ways is psychological and it’s often termed “Recency Bias.” Last week, I had the opportunity to speak about this topic with Victor Ricciardi who recently published Investor Behavior: The Psychology of Financial Planning and Investing. The field of Behavioral finance is rapidly growing and Ricciardi has done an excellent job of assembling the ideas of the field’s leading researchers in his book.Recency Bias refers to the effect that recent events have on one’s psychology
Over the last 30 years of advising investors, I have experienced many different market environments. During that time, investor emotions have ranged from euphoria during the Tech Boom to despair during the Great Recession—and back. Dealing with market corrections is one of the things that’s most difficult for investors. and research shows that recent stock market events tend to weigh heavily on the minds of investors, thus distracting them from information that’s objective about their long-term investment goals. So today, when markets exhibit volatility that’s normal by historical standards, investors have a tendency to overreact, imagining that the current volatility is a precursor to the kinds of once-in-a generation market declines they experienced in 2008. That’s understandable, but it may interfere with their ability to earn competitive rates of return in the future.
Guidelines for avoiding volatile market mistakes
Investors make expensive errors in this kind of environment due to Recency Bias as well as to other factors. The good news is that most of the mistakes are avoidable if you follow these simple guidelines:
- Don’t turn to the news media for investment advice. Their ratings are dependent upon sensationalizing news and making every story seem like a cataclysmic event. Remember, the pundit of the day on CNBC doesn’t know you or your financial plan. They are after ratings. Therefor they can’t offer you credible advice. It’s as simple as that.
- Do put the current environment into context. For example, since March of 2009, the S&P 500 has had 14 corrections of more than 5 percent each of those corrections averaged 8.4 percent. That’s about 2.3 corrections per year.
- Do look for tax management opportunities. Loss harvesting—strategically offsetting gains with losses to manage capital gains taxes–is one way to make lemonade out of lemons.
- Do look for rebalancing opportunities. It is critical to have a disciplined approach to investing. A good rebalancing process brings discipline to chaotic times.
- Don’t revise your strategy unless your investment objectives have changed. In my experience, good things rarely happen when plans are changed in the heat of battle. Good execution can make even the most mediocre strategy superior to an excellent strategy if that excellent strategy is unevenly applied.
Investing can be an emotional subject. The steps above can minimize the negative effects that emotions can have on your portfolio. Good strategy, combined with good execution, can minimize the psychological effects that can undermine a good long-term investment strategy.
Please feel free to contact me if you have concerns about the recent market volatility and its impact on your long term investment goals. My email address is firstname.lastname@example.org and my office phone number is 610-695-8070.