At this point, I’m going to assume you’ve seen the Youtube video titled, “David After Dentist”. The thing was an Internet sensation a few years ago. Towards the end of this hilarious video, David (under the effects of some heavy drugs after a dental procedure) wonders aloud, “Why is this happening to me? Is this going to be forever?”.
Investors might be feeling the same way right now. To say that 2016 has started off on the wrong foot would be an understatement. Through today’s close (01/21/16), the S&P 500 is off 8.56% for the year, however it has reached double digit losses during intraday trading. To put this into perspective, Michael Batnik of Ritholtz Wealth Management recently pointed out that:
“Double digit declines are to be expected, 64% of all years experienced them.”
Michael raises some excellent points in his post, which I highly recommend you read here. Despite the indisputable fact that double digit losses appear to be pretty routine (and temporary), no amount of reasoning through words or data can replicate the feeling of logging into your retirement account and seeing a sizable drop in its value. Whether right or wrong, these emotions are very real. In the heat of the moment, it can be easy to forget that this is not going to be forever.
So why does it feel that way? We have a tendency to project the more recent past indefinitely into the future. This behavioral deficit is commonly referred to as recency bias. It’s what causes investors to be too euphoric at market tops and overly pessimistic at market bottoms. Extrapolating what’s recently occurred often leads to mistakes because if there’s one thing we know about the markets, it’s that the only constant is change. Recency bias is a huge road block to successful investing because it clouds our vision, and prohibits us from thinking rationally about potential outcomes.
A great way to combat recency bias is to invest intentionally. What I mean by that is having a plan. In a perfect world, every investor would make money when the market is going up and not lose anything when the market goes down. Hopefully you’re aware that this is impossible. In reality, the best we can do is create a portfolio and strategy that we can follow in both good and bad market environments. If you want the potential for gains, you have to be willing to accept the potential for some losses too. That’s how investing works. Whether the market is doing well or not, it’s important to keep an even keel and remember that this isn’t going to be forever.