When it comes to investing, people tend to have short memories. During bull markets, as stock values push higher, many investors want to increase their exposure to stocks. Why wouldn’t they? When volatility is relatively low, it can be difficult for investors to recall why they limited their exposure to higher risk assets.
Similarly, when a bear market arrives and volatility increases, investors often want to retreat to the safety of more conservative investments. After all, when volatility increases and stock values fluctuate dramatically, it can be difficult for investors to recall why they chose to invest any portion of their portfolios in stocks.
The fact is, investors often fall prey to a phenomenon known as recency bias. People tend to believe what is happening now will continue to occur in the future. It won’t. The economy tends to cycle from expansion to contraction and back to expansion.
Stock markets tend to cycle from bull markets to bear markets and back to bull markets. Periods of high volatility tend to be followed by periods of low volatility.
We are all susceptible to recency bias and other behaviors that can undermine investment success. In their research paper, The Behavior of Individual Investors, Brad Barber and Terrance Odean concluded:
“The investors who inhabit the real world and those who populate academic models are distant cousins. In theory, investors hold well diversified portfolios and trade infrequently so as to minimize taxes and other investment costs. In practice, investors behave differently. They trade frequently and have perverse stock selection ability, incurring unnecessary investment costs and return losses. They tend to sell their winners and hold their losers, generating unnecessary tax liabilities. Many hold poorly diversified portfolios, resulting in unnecessarily high levels of diversifiable risk, and many are unduly influenced by media and past experience.”
If recent volatility has caused you to question your investment choices, please get in touch. Together we’ll review your goals, strategy, and portfolio allocation and suggest
recommendations which support your goals and risk tolerance.
photo by: Volatility © Dmitry Larichev | Dreamstime.com