Have you heard the saying, “There is nothing new under the sun”? The longer I live, the more I believe this to be true. Sure, new phones, tennis shoes, camera doorbells and robot vacuum cleaners argue differently, but the truth remains – our world (or at least the people in it) really haven’t changed much in the last 1,000 years.
There is a relatively new area of study in business education that explores this truth. It goes beyond economics, finance, and accounting. It is a blend of psychology and business called Behavioral Finance. It embraces the idea that though technology changes, we as consumers and investors are mostly consistent – with short forays into crazy. Some of these actions can be self-destructive. Behavioral Finance attempts to educate us about tendencies that could get us in trouble.
One of these actions that can cloud our judgment is called “Recency Bias”. It’s really a pretty simple idea at the core. We often expect to see a repeat of what has happened recently. Most of you remember the markets in 2008. Recency Bias suggests that you might feel like the next drop will be a repeat of that event.
Looking at another example, take the price of gas. When gas prices are going up and getting painful, we believe that will continue. We think the pain at the pump will never go away. This can drive people to sell their gas guzzling SUV’s or even spend thousands of dollars to convert a truck to CNG (compressed natural gas). When prices return to “normal” they find they spent more money avoiding high gas prices than they would have actually spent on gas.
This example may be about consumers, but it is no different for investors. When the market starts going down there comes a point where you think it will never stop. That feeling of anxiety can make you do the wrong thing at the wrong time. Turning back to our current market, how do you manage those feelings? What can stand up to bouts of anxiety and even panic? Stay focused. Keep decisions anchored to your plan of long-term goals and market norms
In the example of gas prices – the event ended when prices returned to normal. Normal is a powerful idea. Technically we call this a return to the mean (or average). A long-term chart of financial markets would show you they have gone up over time. Occasionally they do depart from normal. These departures, while either painful or euphoric depending on the direction, can have minimal influence on the long-term averages. The drops are the places we experience risk and stress. These are also the places that mistakes are easily made by reacting to the fear.
Panic is not a strategy. Volatility is part of investing and life in general. Over time, normal is more powerful than a short-term market event. If you need help focusing on the right things, let us help.