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How focusing on the recent past can sabotage our investment success

We look at the damage placing too much importance on recent events can cause to your investments.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Benjamin Graham once said, “The investor’s chief problem – and his worst enemy – is likely to be himself. In the end, how your investments behave is much less important than how you behave.”

When it comes to investing, we are constantly having a tug of war with our emotions. But in times of uncertainty and market volatility, our emotions can get the better of us. Lots of investors, for example, get the jitters and push the sell button at the first sign of a market downturn.

These emotional responses are caused by mental biases and shortcuts. For most of us it’s impossible to eliminate them completely, but by identifying and understanding them, we can help minimise their impact on our wealth.

Last time, we highlighted the power of herd mentality on our decision making. This time, we look at the impact of over-emphasising recent events.

This article is not personal advice. If you’re unsure, please seek advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

What’s recency bias?

Recency bias means investors place too much importance on recent events. For no logical reason we tend to think what’s happened recently will tend to continue into the future. Say, if your portfolio dropped 10% in the last few days, this bias convinces us that it will keep on dropping.

Basing investment decisions on recent events is a primary culprit in preventing us from making sound judgements.

It’s especially dangerous in times of market volatility.

Take the 2008 financial crisis for instance. When the markets first dropped, investors rushed to sell their investments. Not only did this result in them locking in losses at the bottom, but convinced the drops would continue, some stayed in cash for years – missing out on the recovery. Researchers have shown that increased trading activity hurts investors’ returns over the long term.

We think this could be for two reasons.

One is that we know crashes have been temporary – after a decline, no matter how severe, investors have tended to recover their losses, the markets stabilised and they saw positive growth over the next few years.

The other is that nobody, no matter how experienced or qualified, can time the market with complete accuracy. The investors that do try and engage in market timing sometimes miss out on some of the best days in the market. Six of the ten best days in the market have occurred within two weeks of the ten worst days.

Take a look at the table below. We’ve highlighted the five best performing days in the UK stock market and what was going on at the time. As you can see bad headlines don’t always mean bad news for the market.

Date Gain (%) Environment
24 November 2008 9.2 Days after the Dow Jones had plummeted to a new low
24 March 2020 8.9 The day after the COVID lockdown started
19 September 2008 8.5 Days after Lehman Brothers filed for bankruptcy
29 October 2008 7.6 Days after “bloody Friday” where many of the world’s stock markets fell by 10%
13 October 2008 7.5 The day the UK government bailed out RBS, Lloyds and HBOS

Past performance isn’t a guide to the future. Source: Refinitiv, Datastream 19/05/20, HL

As Peter Lynch said, “Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”

How can I avoid this?

With markets volatile at the moment because of the ongoing covid-19 pandemic, we need to take special care not to fall into the trap of recency bias.

Here are three tips that can help combat it:

1. Remember we’ve been here before

Before you make a rash decision, step back and look at the wider picture.

Market falls are part and parcel of investing - over the last 150 years, market crashes have occurred around every nine years. Although it’s gut-wrenching to see your investments fall in value, it’s important to remember that every time stock markets have recovered. Remember though that past performance is not a guide to the future.

Stock market drops - lessons from history

Stock markets are supposed to fluctuate. Many investors will overreact to these fluctuations. But, if you can learn to be one of the relatively few that don’t overreact, the better off you’re likely to be. You'll need to review your investments regularly but if you’ve got a diversified portfolio and a sensible long-term plan, it’s often best to stick with it.

As Warren Buffett’s long-term business partner, Charlie Munger once said, “The first rule of compounding: Never interrupt it unnecessarily.”

2. Don’t get tangled up in headlines

Although reading is important, reading countless market updates can easily sway our thinking and lead to panic. You could try and stick to a schedule for how often you check the news (whether that’s daily, weekly or monthly). You should also think about slowing down to question the information before taking any action.

Newspapers are there to make money, not improve our investment performance. So give yourself the best chance you can by surrounding yourself with independent and factual sources of information when making decisions.

3. Speak to a friend or colleague

It can be hard not to fall in the trap, but talking it through with family, friends or colleagues can help. Being challenged by loved ones and justifying your investment decisions will help you focus on your reasons for investing and make sure you’re making more objective decisions– not falling into the trap of recency bias. Remember though to still keep in mind your own objectives.

But we understand this can sometimes feel personally invasive, so why not speak to a professional?

Speaking to someone who’s qualified and experienced can help you make rational, sound decisions. They can offer you a fresh perspective on the fluctuations in the market, make sure you stay focused on your long-term plan and help you separate emotions from your decisions.

Our financial advisers are carefully selected because of their ability and comprehensive knowledge of investments. You can be sure they are here to help you make the best investment decisions.

If you would like to find out more about advice, contact our advisory helpdesk. Initially they will help you determine whether you actually need advice, for many clients we provide information to assist with managing their investments without paying for advice.

If advice sounds right for you, we'll set up a free initial meeting with a financial adviser. No advice will be given as part of the initial meeting. Please note that if you decide to proceed, charges will apply.

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You’ll need to book your call back by 30 June 2020. Our advisory helpdesk will call you at a time that suits you. They don’t provide the advice but can explain more about our service and charges. If you do decide to take advice, you will need to agree to the advice charges by 30 September 2020 to qualify – see full terms in the link below.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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