2022 was one of the worst years ever for financial markets. And yet speaking for myself and my own my financial plan, I remain on track to achieve each of my financial goals. The reason for this is pretty straightforward. Although I invested in one of the worst years of the market, I also invested in some of the best before that.
By staying the course, no matter how hard it gets, we can each achieve our financial goals. If only it were that easy. Our brains and over 400 recognised cognitive biases lead us astray.
Recent events are very good at catching our attention. This is particularly true if the event is unusual or negative. And when these bad or shocking incidents happen, we assume they’ll happen again. This is known as ‘recency bias’. It’s a cognitive phenomenon where our minds give more weight to recent events than those that have happened in the past.
Take an earthquake, for example. When an earthquake happens, it’s not uncommon for aftershocks to ripple through the area, causing more damage in the days that follow. Yet tourism in these places can be affected for months, sometimes years. Some tourists will visit other parts of the world that are susceptible to earthquakes, while avoiding the locations that have most recently been hit.
As psychologist Daniel Kahneman points out, assigning more weight to recent events than to long-term averages can result in bad decisions. It’s not our fault, though. Our brains are hardwired to assume that big losses will be repeated. My house was struck by a ‘once in a lifetime’ flood in July 2021. Even though I know and understand recency bias, it doesn't stop me keeping a close eye on the weather all through July just in case.
When it comes to the stock market, big losses can be followed by more big losses, sure. But often, they’re followed by big gains. Ny changing your investment strategy, perhaps by altering your asset allocation, or by selling out of the stock market, it’s likely you’ll miss the upside.
Take a look at the graph below. Historically, as the data shows, you've either had a huge rally or some further losses. Where are we in 2023? We seem to be following the ‘big gains’ pattern. The Nasdaq is up 31%, the S&P is up 16%.
With that in mind, if you’ve not already panic-sold your stocks, I think you should give yourself a pat on the back. You’ve managed to resist a challenging human urge.
And that’s not the only reason to celebrate. If you’re invested in one of our Navigate portfolios, you’re benefiting from a level of diversity that solo investors (and even investors working with other financial planners) often overlook.
This is down to another bias that often affects investors. ‘Familiarity bias’ occurs when an investor has a preference for UK stocks, even when presented with other options that can increase portfolio diversification or lead to a better return. The FTSE 100 is up only 2% year to date and UK stocks represent less than 4% of Navigate portfolio.
Staying the course often means going against your own emotions — especially when everyone around you from friends to journalists is telling you to do something different. Follow the plan.
As I said in a discussion with a client this week, successful investing usually involves doing the complete opposite of what you feel like doing at any given time.
Staying the course also means that thinking and acting in the best interest of the long term, even though the short term can feel much more important.
Staying the course means focusing on the things that you can control. We do this in our WealthMap planning sessions. We’ll go through how you spend your money, where you spend your money, and who you spend your money with.
By doing this from the outset and building resilience, when that urge to “mix things up” comes along, we can always show where you are now and where you need to be in the future.
If WealthMap says you need to do nothing, then that's what you should do. But it’s damn hard at times.