Recency Bias

There’s no question – 2020 has been one for the history books. For almost everyone, it’s been an emotional rollercoaster in more areas than one. Whether it’s health, money, employment or the many other factors impacted by COVID-19, 2020 has brought many sleepless nights worldwide.

Here at Cambridge, we take great pride in being a resource for information, a voice of confidence, and even an outlet to vent fears and frustrations in times like these. This year has proven to be a true test of investor emotions and thus far, has been a great example as to why eliminating human bias and taking the emotion out of investing is as important as the decision to invest in any particular stock, mutual fund, or ETF in the first place.

In our business, perhaps the most common form of human bias comes in the form of recency bias. Recency bias involves assigning more weight to current or recent events and allowing the emotions that come with those events to factor into our short-term decision making. Our tendency to exhibit recency bias is what leads many investors to try and time the market.

At the end of 2019 it would have been easy to come to a decision to sell the bond portion of your portfolio and join the party in equities after a year which saw the S&P 500 gain 30%.

On March 23^rd, 2020 it might have been more comforting to sell out of the stock portion of your portfolio and instead opt for the relative safety of bonds.

The problem with the “all-in” or “all-out” approach to investing is that unless you nail it on the head nearly every time, you increase the risk of making a mistake that could be catastrophic to your long-term plan. In fact, a 1975 article published by Nobel Laureate William Sharpe concluded that for a market timer to outperform a passive portfolio, they would need to be accurate 74% of the time. To further complicate the idea of market timing, markets don’t give green, yellow, or red lights. Consider the graph below from our partners at Vanguard illustrating the recovery of the S&P 500 Index from March of 2009 to February of 2011 despite the news headlines at that time.

The fact of the matter is that it’s downright impossible to predict what happens next. So…what can we do about it?

In our view, a rules-based investment strategy that removes emotions is the best approach. We focus on making sure your allocation aligns with your tolerance for risk, time horizon, and the changing landscape of your financial life. We don’t pretend to know what happens next but we plan ahead by diversifying across multiple asset classes to ensure that your way of life doesn’t have to change because of what happened in the stock market this week.

With the exception of a few months, the majority of our rebalancing trades over the last decade involved the sale of stocks and the purchase of bonds and alternatives. At the time it may have felt like we were sacrificing potential upside – and we were – but for good reason. We created that plan for a reason and we’re going to stick to it.

Things we found interesting this week:

If all you are seeing is bad news – there might be an explanation for that: Click Here

More stimulus checks could be on their way but this time to less people: Click Here