Understand your behaviour – Grow your wealth
Recency/Recentism – is one of the Behavioural biases (a Cognitive bias) that can wreck your wealth, and is especially relevant in these volatile, ‘late-cycle’ times.
Trying to understand a person’s behaviour is hard enough, as soon as you add money into the equation it becomes infinitely more difficult. This is the first in a series of blogs and articles trying to demystify financial behaviour and put some clear action steps in place to make sure they don’t sabotage your wealth. (At the end of the series I will be putting them all together in an eBook). When you look at the long list of biases (like HERE), many of which you’ll probably recognise in the behaviour of those around you (and you – if you’re honest). Marketers and salespeople make good use of these biases to influence (aka manipulate) your buying behaviour. If you want to inoculate yourself against slick salespeople and irritating family arguments, a better understanding of these biases can help. These biases influence our investment behaviour too, and that can have a devastating effect in the long term. We’ve all heard the phrase “it is not that you’re a bad person, it is the behaviour that is making you look bad” – this is certainly true of financial behaviour.
Financial behaviour extends to every aspect of the ‘wealth equation’ (income minus consumption equals wealth – you can read more HERE if you missed that blog). We let our fears and prejudices stop us earning more income, we feed our ego which impacts our consumption, and we allow biases to influence how, when and where we invest our wealth.
The Recency bias is the inclination to place more weighting on new rather than older data. In finance/investment/economics one of the most visible ways that this manifest itself is in the assumption that the market will always look the way it does today. Intuitively we all know that is nonsense, cycles in the economy have been happening for centuries, but it doesn’t stop us piling into the market when it’s flying – or bailing out as soon as it turns south.
Ignoring the past, especially in investment is dangerous, but it happens all the time which is why we have to keep going through the pain of poor judgement. We think that cycles are never going to end, and the last one is the last one – ever.
Let’s look at the Credit Crisis of 2008. That was a result of a horrifically under-regulated (American) market which allowed the “bundling” of completely rotten mortgage loans (that had zero hope of ever being repaid,) into shiny new “products” that investors were falling over themselves for. This was exacerbated by the Rating’s Agencies who gave them AAA ratings (yet came out of the crisis unscathed). In the fallout, strict regulations were put in place to stop that ever happening again, and more specifically, to prevent the failure of financial institutions. Obviously, new cracks that can be exploited soon appear. The aftermath of the Credit Crisis led to a tightening of credit, making it more difficult for entrepreneurs and small business to borrow money. Those regulations were called ‘Dodd-Frank’ and Trump is now going to throw them out of the window. You can just hear those bankers rubbing their hands in glee.
New is bright and shiny and we all optimistically like to think we have learned from past mistakes, but have we really? Greed and fear are the underlying animal instincts in all of us – how dare governments deny us opportunities to amass wealth! Of course, if it all goes pear-shaped they have to pick up the pieces (haha!)
What can we as individuals do to temper this ‘Recency’ bias? When you see something new, bright and shiny that you want to invest in, don’t get caught up in FOMO, take the ‘gap’. The ‘gap’ is the time between the impulse and the action – the longer the better. Impulsiveness is a wealth killer. During the recent currency wobble, the impulse was to bail out of investments and get the money offshore. Hopefully, knowing how slowly the wheels at SARB turn, sense has now prevailed as the exchange rate drifts on back. The importance of this example is that ‘recent’ does not have to be a long time. Can you imagine, therefore, the impact of the longest bull-run in history that the West is currently enjoying? Unfortunately, while we had pockets of good growth, we South Africans pretty much lost out on this bull run which coincided neatly with the Zupta years.
Some people feel that our attention spans are getting shorter, so we have to be fed information in 140 character ‘sound bites’ but I don’t think this is true. There is an information overload, and not all of that information is trustworthy. The current US President has uttered more lies in 2 weeks than Nixon in his entire presidency with no repercussions. ‘Fake News’ and ‘Alternative Truths’ are the new buzz words – but it is also much easier to fact check. Even our fearless leader (SA Inc) got caught in a whopper last week (No farmer murders). Compared to Trump though he is still very low on the “Pants on Fire” Index.
Action: Before making an investment decision based on recent trends, do some research into the past. Objective-based investment should be the primary driver of your investment, not what happened last week. If you’re day trading then, by all means, look what happened 5 minutes ago, but if it is your retirement in 10 or 15 year’s time, chill.