Is This Dangerous Bias Kicking In Right Now?

Wednesday, October 24th, 2018

Good Morning Relaxing Retirement Subscriber,

When we closely examine investor behavior and results, as I have for decades, there are several dangerous investor biases that the majority bring to the investing table each day which drive their investing behavior, and lead to the awful results reported by DALBAR each year.

A couple weeks back, we discussed the Recency Bias which I illustrated with the “verb” challenge they have, i.e. when they view the recent performance of a particular investment, they often state, “ABC fund is going up,” or “XYZ fund is going down!”

What they are unintentionally suggesting when they say “going” vs. “gone” is:

  • first, XYZ has recently “gone” down in value, and,
  • second, because it has recently “gone” down in value, it will continue to go down.

In other words, too many use it as predictor of what is to come and that’s where the danger lies.

While it may “feel” as though an investment which has recently gone down in value will continue to go down, and vice versa, the reality is that recent performance of any investment has never shown itself to be an indicator of what is to come next.

There simply is no correlation.

Negativity and Loss Aversion Bias

Another bias which can rear its ugly head with the downturn in global equity price this month is Loss Aversion Bias.

Loss Aversion Bias stems from the ingrained “fight or flight” defense mechanism in our brains.

While that served cavemen well, and saved lives, it is incredibly destructive for long term investor success.

The key to overcome this is education and consistent reinforcement in good and bad market climates, i.e. a rational understanding and realization that market corrections and crashes are normal and temporary, and simply part of your investment experience, i.e.,  

  • Since 1980, the S&P 500 Index has experienced a peak-to-trough intra-year market correction of 14.1% per year, i.e. at some point during the year, prices fell 14.1% on average.
  • Since 1945 (72 years), there have been 14 market crashes with the average temporary drop in prices of 30%. That’s an average of once every five years.
  • In spite of all of these, market prices and dividends have risen dramatically outpacing the risk-free returns of Treasury Bills by 7.9% per year since 1928.

Another way to look at this is higher expected returns are the reward for your willingness to accept higher short term volatility with some of your Retirement Bucket™ holdings.

While this is challenging to remember during volatile markets like we’ve experienced recently, nobody earns market returns without experiencing market turbulence, corrections, and crashes.

As Peter Lynch said, more money is lost anticipating market crashes than the crashes themselves.”

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)