HHWM Investment Insights: Behavioral Biases – What Makes Your Brain Trick?
Written by Jason Hiley
Written by Jason Hiley
2014 may go down in financial history as the year that a lot of things didn’t happen to investors. For example, despite numerous nervous headlines that it might be best to prepare for the worst, there was no universal stock correction. And despite Federal announcements on tapering quantitative easing in the U.S., there was no major slump in the bond markets.
Another non-event for globally diversified investors was that we were not rewarded with higher annual returns relative to a concentrated, stay-at-home position. Large U.S. companies happened to enjoy a remarkable, double-digit year, even as other markets experienced negative to ho-hum results, especially for international, emerging market and small-cap stocks.
In light of all that did not happen, there is one more thing I hope continues to not happen. I hope you do NOT react to the current market by succumbing to two common behavioral biases: Recency, or giving recent events more weight than they deserve; and Tracking-Error Regret, or abandoning your personalized diversified portfolio to chase last year’s Old Glory returns.
In his article, “There’s a Perfect Storm Brewing,” financial author Larry Swedroe describes the risks associated with chasing past performance. While the U.S. S&P 500 Index has outperformed the MSCI EAFE (international stock) Index since 2010 by an annualized return of around 9 percent, the MSCI EAFE happened to deliver about the same outperformance in reverse from 2002–2007. Clearly, the tables can turn abruptly and destructively for an undiversified investor. As Swedroe says, “Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket.”
There remains decades of resounding evidence that one year or even several years does not a strategy make. That’s why, come what may, we remain as convinced as ever that individualized diversification is the right policy every year. Maintaining a globally diversified portfolio according to your personal goals and risk tolerances does not guarantee that you will outperform other lucky scores you might have made instead. But it continues to offer the most rational approach to reaching your desired destination while managing the rocky risks along the way.
As always, we welcome the opportunity to explore your particular goals and investments in light of this and any other market climate.
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