Wouldn’t it be lovely to time our way in and out of investment markets with full knowledge of the future?
It would certainly be profitable and the anxiety of negative markets would be a thing of the past.
Full knowledge of the future is unfortunately only available to us once we get there — although, when we then look back, it can seem the answers were obvious.
That is called hindsight bias, leaving us with feelings of frustration and regret that we did not take the actions that now seem so clear.
The problem with hindsight bias is it can influence our future decision›making.
Believing we knew all along and failed to act; we do not want to make that mistake again.
Next time, thinking we are better at predicting the future than we really are, we do take action.
Because we are working with less›than›perfect information, our decision› making is riskier. Outcomes could just as easily work against us as for us.
Hindsight bias and our resulting focus on taking action can also mean we fail tolearn lessons from our experience that might improve investment outcomes in the future.
The push to action is because we feel the pain of a negative year much more strongly than the pleasure of a positive one.
Therefore, we decide we should move from a growth› oriented investment to something more conservative, or to sell altogether and put our funds in the bank — until what we see as safety returns.
Given our imperfect information on the future, timing our changes is exceedingly difficult.
Even if we get the timing of our exit right, we then need to figure out when to go back in.
Stories abound of investors who wait, right through a rebound. Or those who look imperfectly into the future and decide that markets are overvalued and due for a fall — only to find themselves sitting on the sidelines while markets continue to go up.
One day they will be right. Markets will fall. But what has the cost been in the meantime?
Perhaps markets have already fallen when the investor takes action.
If they get their re›entry timing wrong, they will miss some, or much, of the rebound that would recover their value
— thus creating the very loss they were trying to avoid. And when markets rebound, they often do so very strongly and quickly.
More often, an investor’s best course of action is to stay disciplined to the journey they set out on.
If that was with a 10›year focus and the knowledge that the occasional year would be negative why react now?
That is not to suggest that we should never make changes.
A negative market might teach us we do not have the stamina for volatility we thought we did.
Or that we need to put funds aside in a buffer account (a bank account or more conservative allocation) to give us greater comfort.
We might increase our level of diversification.
Or perhaps we do need to move to a more conservative mix (and stay there).
Any changes we make should be done in a considered way, not as a knee› jerk reaction to a negative market event.
The potential outcome of that is to destroy wealth, rather than enhance it.
Stephen McFarlane is a director and adviser with Central Wealth Ltd, based in Timaru. The opinions expressed in this column are his own.
