Don’t build your future based on what’s happened recently
Let’s be honest, everyone in Dublin and most people around the country (at least outside Kerry) thought the Dubs had the All Ireland won before the first match. Of course they were going to win, sure hadn’t they won it for the last four years! Uninformed people were saying this without considering or even knowing anything about the quality of the Kerry team. Then Jonny Cooper of Dublin got sent off and the whole picture changed, with the Dubs very happy to escape with a draw and go again the second day. While they went on to win, they were lucky to get that second chance. It showed that recent history (the previous 4 All Irelands) doesn’t determine the future and that one small factor can change everything. We see it in sport all of the time – the past is the past, and its not always a good guide to the future.
The same rules apply in business. It’s very dangerous to base decisions only on what happened recently, which is known as recency bias. It is the phenomenon where people recall and give more credence to very recent events, as opposed to events from the more distant past or indeed other tried and trusted bases for making decisions. And often there is no rhyme or reason as to why recent events are in any way more credible.
It’s in the world of investing that we quite regularly see recency bias rearing its head, often with very damaging consequences. Some investors make tactical investment decisions based on how the market has been performing recently, rather than considering the fundamentals of a market. As a result, these investors tend to think that a bull run will continue forever and that they should pile in “because the market has been racing ahead”. Bear markets tend to get forgotten about during a good run in the markets. Of course, we know from experience that past performance is not a guide to future performance – but sometimes it is hard to convince investors otherwise… Think of all the Irish investors who were overweight in property and Irish bank share in the early 2000’s, because these had been such good performers in the previous years. They saw their wealth wiped out, largely due to their recency biases.
We help our clients guard against recency bias. We plot uncertainties into your financial plan, challenge your assumptions and biases and show a range of different potential outcomes, rather than a single one based on recent events. As a result, we help you plan for every scenario, irrespective of whether your assumptions based on recent events actually come to pass or not. We ensure your plans are not derailed by recency bias.
Using our expertise, we can demonstrate how a continuing bull run will impact your financial plan. But we can also quickly and easily demonstrate how a dip in markets will also affect you. Considering both scenarios brings a greater level of validity to the actual investment assumptions that are ultimately used.
We can also help you manage any potential recency bias in other areas of your life – maybe your employment situation or your health. This is important for us with the client who says, “My company has been growing in recent years and I couldn’t tell you when I was last sick”! People can think they are bulletproof, based on recent experiences. We are happy to have the “What if” conversation about the impact on your plan if you were to be involved in an accident or to get sick. You can then see the real impact of these events on your financial plan. Maybe your experience in recent weeks / months / years is not enough…
Recency bias is a very real threat to building a sturdy financial plan and achieving the outcomes that you want. Yes it’s worth keeping an eye on what happened in the past. But it’s what will happen in the future that will now determine if you will achieve your goals and objectives in life.