Recallability Bias And Reasons Not To Panic

Picture courtesy of Krysten Newby on Flickr (here). 

Picture courtesy of Krysten Newby on Flickr (here). 

Emotional decisions made about money almost never end well, whether it is buying an unaffordable coat or selling investments because the world may end. All of us have been in arguments with our significant others. Often things are said that we come to regret later because we said them without sifting through the influence emotion in those contexts. Usually, a sincere, “I’m sorry” is all that’s needed to move forward, but when it comes to a portfolio allocated to meet obligations five, ten or 30 years in the future, there is much more at stake. Not more because money is more important than personal relationships, but more because it is harder to remedy financial mistakes.

The most prevalent emotional influence we see affecting investors today is recallability bias, or the influence of past events on current decisions.

Beginning in 2007, the U.S. stock market began to roll over as information about the slowdown in housing surfaced. From the top to the bottom, the Dow Jones Industrial average fell about 50 percent over the course of 18 months. For many Americans nearing or in retirement, the decline was devastating. And for many, the memory of the crash is still prevalent. Simply put, separating 2008 from volatility in 2016 is difficult, if not impossible. 

So far this year the U.S. stock market, measured by the S&P 500, has declined 7.45 percent and almost 10 percent from the all-time highs it set in May 2015. Never do we want to downplay declines, however, context and historical perspective are necessary to assess whether these declines are ‘abnormal’. 

So, how often does the stock market decline? According to research done by Ben Carlson, a well-known wealth manager and industry blogger, every other year since 1950 has had at least a 10 percent correction. 

Stocks go up, but stocks also go down. In March 2009, less than seven years ago, U.S. stocks bottomed then reversed to climb higher over the course of the next seven years. During that period of time, the Federal Reserve’s monetary policy aided in the increase, but also limited volatility. That era is over as we now enter a period of more normalized reactions to economic news and events around the globe. Without the Fed’s backstop, volatility is back and that means we trend toward more frequent ups and downs. 

What do you need to do? First, ignore emotional reactions. For most that is impossible which is why they work with advisors. Make sure your advisors limit emotional biases as well, because research shows fund returns tend to be higher than investor returns as individuals move their money in and out of the market to the detriment of their savings. 

Recent research by Vanguard and Morningstar used cash movements (buys and sells) of mutual fund data to highlight the price of panic. They measured a decade of data, ending September 30, 2015, and found the average mutual fund returned 4.18 percent annually. However, for investors holding those mutual funds, their return was a lower 2.59 percent return, a difference of 1.59 percent. The difference, 1.59 percent, is due to investors moving in and out of the market instead of buying and holding. 

So, markets are volatile, but remain rational. Hire an advisor and stay the course.