If you’re investing for retirement, the biggest roadblock between you and your long-term goals probably isn’t volatility, slow growth or the occasional bear market. Chances are, it’s you—specifically, your emotional impulses. We Earthlings have hard-wired impulses to make the wrong investment decisions at the wrong time. Understanding these triggers and knowing how to spot them is key to retirement-investing success.
First, a question: How did the steep volatility in early 2016 make you feel? Were you scared? Worried stocks weren’t a wise buy?
If so, you weren’t alone. According to a Gallup survey taken between January 29 and February 7, 60% of retired investors said it wasn’t a good time to own stocks. Three months earlier, only 45% said the time wasn’t right. In January/February, because of what stocks had just done, substantially more folks were sure the future would be dismal. But it wasn’t! Markets rallied after February 11 and, by May 13—when Gallup started conducting Q2’s version of the survey—the S&P 500 was actually up about 1%.i That survey showed folks were much more optimistic.
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This mentality is a behavioral error called recency bias: the overwhelming human tendency to let what just happened color our view of what will happen. We are hard-wired to extrapolate the recent past forward, often using straight-line math. We think recent gains will continue indefinitely, at similar rates. When stocks fall, we think they’ll keep doing so, at the same pace.
This leads to dangerous decisions, like heat-chasing when stocks are hot and panic-selling when volatility gets rough—often the opposite of what’s best. Recency bias made many investors go hog-wild for tech stocks in early 2000, just as that market was peaking. Recency bias also made folks scramble for the exit in March 2009, just as the Financial Crisis was bottoming out. Acting on these impulses had devastating consequences.
A recent piece by Wall Street Journal personal-finance writer Jason Zweig underscores this point:
Individuals are no better, of course. As an enthusiastic investor in Nasdaq technology stocks wrote in one of the Yale surveys, “The market today is not comparable to Oct. 19, 1987. WHOLE DIFFERENT WORLD.” That was on Mar. 10, 2000, the very day the Nasdaq bubble peaked.
No wonder the great analyst Benjamin Graham wrote in his book “The Intelligent Investor,” after which this column is named: “The investor’s chief problem — and even his worst enemy — is likely to be himself.”
To be a true contrarian investor, remember that you have to act contrary to what others are doing — but also to what you feel like doing yourself.
Successful retirement investing often requires doing what feels counter-intuitive, even wrong. So when you get strong emotional impulses to do something with your investments, if your primary rationale is “because they just ______, I must ________,” it’s time to take a long pause and remind yourself to ignore the recent past.
iSource: FactSet, as of 8/24/2016. S&P 500 total return, 12/31/2015 – 5/13/2016.