“What we believe is heavily influenced by what we think others believe.” (Thomas Gilovich)
Do you remember 2017? It wasn’t that long ago, but few of us can probably recall what markets did that year.
For the record, it was a great year for stock markets. The JSE All Share Index was up 21%. The MSCI All Country World Index gained 24%.
Given those numbers, you wouldn’t be surprised to know that US companies were posting record profits that year. New home sales were booming. Factory activity was at multi-year highs.
By the end of the year, markets in most parts of the world were at record highs. It felt like a great time to be an investor.
Except that it wasn’t. Because the very next year markets gave their worst performance since the global financial crisis in 2007 and 2008.
Reflecting
For investors, there are really two lessons here.
The first is that, sitting here today, few of us know, or care for that matter, what happened in the markets in 2017. But, back then, it would have felt like the most important thing. We would have believed that whatever information was coming through was vital to our eventual outcomes.
That is because our attention is inevitably drawn to things that are happening right now. That is how our brains work. If we didn’t notice the snake right in front of us, we could step on it and have to face the consequences. In terms of survival, that is more important than thinking about what we will have for dinner on Friday next week.
But investing doesn’t work that way. What is happening right now is almost never the most important thing to focus on. If we continually reacted to current developments, we would keep changing our portfolios – and there are many studies that show how that hurts performance in the long run.
The best way to ensure you reach your long-term goals is by sticking to a clear plan, and letting your returns compound over time. Which means that the most important information to you is not what markets are doing right now. It is how they behave over many decades.
The rearview mirror
The second lesson is that what is happening right now is also not a good indicator of what is going to happen next. Strong markets in 2017 were followed by the poor returns of 2018.
Again, because our minds have evolved to focus on the present to support our survival, the information we place most emphasis on is what has just happened. Technically, this is called recency bias. Our view of the future is always most heavily influenced by the most recent past.
At the start of 2018, our view of markets would have been most prominently coloured by what had happened in 2017. Since returns has been so good, our natural belief would have been that they would be good again.
Until they weren’t. At which point, our exuberance may well have turned into pessimism based on what was happening right then. As markets suffered ongoing losses, we would have come to see that as the natural order of things just as quickly as we had accepted the good returns of the year before.
This is why investors chase performance – hoping to pick the next big stock or top-performing fund manager by looking at what has done well in the recent past. This is never a successful long-term strategy, because we’re focusing on short-term information that is far less important than what happens over much longer periods.
As author Joe Wiggins puts it:
“Attempting to be a long-term investor while obsessing over the short-term fluctuations of financial markets is like starting a diet but filling your kitchen with chocolates and cakes; you might still achieve your goals but you are really making it hard for yourself.”
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Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.
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