Recent returns and your next investment decision

By Michael Sicuranza, CFP®, CPA, AEP®

When the market makes a big move, it's natural to feel like you should do something about it. After a strong run, putting more money into whatever has been winning can seem like the obvious choice. And after a drop, selling can feel like the only responsible thing to do. Either way, the latest experience starts to feel like a preview of what's coming next.

That pull has a name. Recency bias is the tendency to give recent events more weight than they deserve when we form expectations about the future. In investing, it can make a few weeks or months of returns feel far more telling than they really are.

You can keep an eye on the markets and still be aware of this tendency. Before you act on a recent move, ask yourself how much it really has to do with the decision you're making.

What happened versus what you expect

Say you notice that one part of your portfolio has been doing well lately. What you've observed is that the investment went up. What you might be predicting is that adding more now will lead to more of the same. It's easy to blur those two together, but they're different statements.

The same goes for a rough stretch. A decline has happened, but that alone doesn't tell you another one of the same size is on the way. Past performance does not guarantee future results.

Here's a simple exercise to try before you act. Write one sentence about what you know and a second about what you expect. If the second sentence leans mostly on the first, give yourself some time to consider other explanations and other ways things could play out.

Remember what the money is for

Money you've set aside for next year's expenses has a very different job than money you're investing for a retirement that's decades away. The right mix of investments depends largely on your time horizon (when you'll need the money) and on how much risk you're willing to take and can afford to take.

Money is a tool, and its real value comes from what it lets you do. It might pay for a child's education, carry you through a career change or give you more say over how you spend your time. A conversation about your holdings, returns and risk is most useful when it starts with what you want the money to do for you.

Has your spending timeline changed? Has your income become less predictable? Do you have a big expense coming up that you'll need cash for? Changes like these can be a good reason to revisit your plan, even when the headlines are quiet.

A dramatic headline, on the other hand, may not change what your account needs to do at all. Urgency in the news doesn't automatically mean there's urgency in your household.

Give any change a fair hearing

Before you talk about any specific fund or stock, try saying out loud what you're trying to accomplish.

“I want to make sure next year's tuition is there when we need it” gives the conversation a clear purpose.

“I want more of whatever's been winning” doesn't give you much to work with.

From there, think through what happens if you act and what happens if you wait. Selling can trigger taxes or costs, while buying can add to exposure you already have somewhere else. Leaving things as they are has consequences too, especially if your needs have shifted. None of these choices should be made just to quiet the feeling that you need to do something.

It's fair to ask your advisor what would make a proposed change appropriate and what could make it disappointing. You should be able to explain, in plain language, how a recommendation connects to your situation.

Give yourself permission to slow down

If a decision isn't urgent, pick a date to come back to it and decide what information you'll need by then. That way you have a process for responding, and every new headline doesn't send you back to square one.

If you make financial decisions with a spouse or partner, talk openly about what's making each of you uneasy. One of you might be focused on a near-term expense while the other is thinking about a long retirement. Putting those concerns on the table is often more useful than arguing over whose market prediction is right.

Recent results deserve context. Your next decision should also reflect the life your money is meant to support.

If you already work with us, or you're thinking about it, we'd be glad to help you connect your investments to your financial priorities.

Investing involves risk, including possible loss of principal. This article is educational and does not recommend a particular investment or transaction.

Sources

Morningstar, Why recency bias is dangerous to investors

U.S. Securities and Exchange Commission, Investor.gov, Asset Allocation and Diversification