Ah, at long last, summer is here. Have you noticed how quickly it feels as if the sunny days will never end? This is called “recency.” Behavioral psychology tells us that, compliments of our frontopolar cortex, our brains are heavily influenced by near-term events, even when there’s no good reason to be. Every summer, recency tricks me into convincing myself that I could be more regular at my early a.m. workout at the gym. Every winter, I end up readjusting when the dark days return. Not such a huge deal for my fitness regimen but, for investors, unchecked recency can have serious consequences.
As if the market is also rejoicing at the arrival of fair weather, most asset classes ended this second quarter on a high note. It’s gratifying to see the improved numbers in our financial statements. But it would be a mistake to drastically change your financial fitness regimen simply in reaction to the recent growth spurts.
Just as when plummeting markets trigger our panic-button flight instincts, recency can trick us into chasing high-flying asset classes, falsely feeling as if the party will never end. Additional behavioral traits further aid and abet our desires to chase recent returns – such as herd mentality (“Everybody else is loading up on emerging markets; I’d better too.”) and overconfidence. (“This seems like a sure bet this time.”)
Market growth spurts are unreliable predictors of whether or how much future growth will occur. Even a rapid glance at Dimensional Fund Advisor’s “crazy quilt chart” tells us that. In its color-coded layout of which asset classes have been the winners and losers in past years, it’s clear that the only discernible pattern is that there is none.
In lieu of paying much mind to recent market returns, diversification offers you wide, more manageable exposure to the market’s long-term expected returns as well as a smoother expected ride along the way. Perhaps most important, it eliminates the need to try to forecast future market movements, which helps to reduce those nagging self-doubts that throw so many investors off-course.
Enjoy the summer while it lasts. But hang onto that winter coat for when (not if) the seasons change.
For more information or to set up a consultation, contact Pathway Financial Planning at or email firstname.lastname@example.org.