We Are All Biased
As some of you may know I am a lifelong fan of Aberdeen Football Club. This meant from the age of 16 to 21 I experienced a period of success that is unlikely to be equalled in my lifetime. Beating Bayern Munich, Real Madrid and the like was commonplace and trophies came ten-a-penny. As a result I expected my team to always be successful.
Now, having been starved of trophies since, my appreciation in seeing my team playing well once more and being the nearest (although distant) challengers to Celtic is far greater than if this had been the situation thirty odd years ago. Then I would undoubtedly have been calling for the manager’s head if we did not win something every year.
Psychologists have a name for this – recency bias – and in a nutshell it is when we tend to expect that what has been happening lately will continue to happen. It is not only football fans that are guilty of this, investors, sadly, can succumb even more easily to this phenomenon.
Ten years ago today the FTSE 100 started its fall which ended up totalling 45% over the next eighteen months. When the market reached what we now know to be its bottom in March 2009, recency bias meant very few were prepared to put their money in the markets at that time. Instead most people wanted to see if the “rally” was going to be sustained. Once they saw it was and the market was considerably higher they felt more comfortable investing in the expectation that recent increases witnessed would continue. Recency bias once more.
Now I sincerely hope we do not witness another period like 2007-09 in my investing lifetime but it is important to be aware of how our psychological make-up can interfere with our decision making. For example, if in March 2009 I said that for the next eight years the FTSE would increase by 5% per annum with inflation averaging less than 2% giving a real return of 3% and this would be considerably more than holding cash on deposit, I believe most investors at that time would have been happy.
However if tomorrow the FTSE fell back to 5200 I am pretty sure happy would not be the emotion you would be feeling even though this would be the equivalent of the 5% per annum return I mentioned above.
This brings me on to another psychological behaviour – loss aversion. Studies have shown that the pain of losing something is twice as powerful as gaining. As an Aberdeen fan this hypothesis is undoubtedly true and is probably the reason behind my going grey in my thirties!
Advertisers use words such as “don’t lose out” and online retailers are keen to point out that only limited numbers of whatever item you are looking to buy are available in a bid to trigger this emotion. It is also why when markets do fall panic can set in very quickly as the fear of losing dominates the more rational impulse which would be to sit tight or even invest more.
The reason I bring this up now is even though it is less than ten years since we suffered the banking crisis I suspect a few clients have started to “expect” to see the value of their investments and pensions rise year on year. Now this may well be the case, but we will experience a pull back at some point and it is important that you are prepared for this and understand that it is normal market behaviour.
As for my team, the loss I am sure all Dons fans are averse to just now is losing our manager, as the last thirty years have shown getting a good one of those is easier said than done!