Don’t build your future based only on what’s happened in the past
Let’s be honest, who really saw Sinn Fein winning the numbers of seats that they won in the recent election? After all, they had never come close to winning such a large number before. And we also see surprising results all of the time in sport – who really thought that England wouldn’t win the Rugby World Cup last year after such a comprehensive win over the All Blacks in the semi final? And sure South Africa were no great shakes.. These events show that recent history doesn’t determine the future and that one small factor can change everything. We see it in politics and 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 mid to late 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.