Why having a short memory can hurt investment returns

Image by Alexas_Fotos from Pixabay

Some people have really short memories. Investing is one of the most emotional pursuits that many humans engage in, yet so often, we seem determined to make decisions based on the recent past rather than on long-term history. Behavioural economists call this phenomenon “recency bias”. In simple terms, it means people overweight what has happened in the recent past and extrapolate it into the future on the expectation that the future will be more or less like what they’ve just experienced. On March 9, 2019, we hit the 10-year anniversary of the bottom of the bear market caused by the global financial crisis (GFC). Those were frightening times. People were genuinely worried about their financial futures. The ensuing decade has been relatively benign and rewarding for stock market investors. The question that it begs is: are people still sufficiently mindful of what happened in 2008-2009? Obviously, no one can reliably predict when the next market downturn will come or what will cause it. I can also tell you that people still ask about how they should be positioning their portfolios, given that the bull market has run as long as it has. In order to maintain some semblance of perspective, I’ve cut out the 10-year performance chart of the TSX from March 9, 2009, to March 8, 2019. It’s a squiggly line, but the trend is undeniably upward.

I’ll be showing the chart to clients as they come in for their portfolio reviews this spring. Just the facts. I’ll ask them to look at the chart and to tell me what they think it means. Speaking personally, I don’t think it means much. My random impressions and observations are as follows:

Markets are volatile
Markets often revert to the mean (i.e., bad times are frequently followed by good times)
The past decade has been reasonably kind to investors
Notwithstanding the point above, an absolute return of 110.71% over a decade is good, but not great
Most importantly, people can lose perspective when one of the worst periods in recent memory drops off the chart because it happened more than 10 years ago

The last point is the most important to me. The first cousin of recency bias is start date bias. Almost any chart of almost any investment will look good if you start keeping score at the point where that investment was near a generational low point. To wit, the 11-year return for the TSX is barely in positive territory. Think of it this way. If something drops by 50% (which is approximately what happened to the TSX during the GFC), it takes a 100% gain just to get back to where you started. Stated another way, people who look at ten-year data might think that the TSX is set to continue to return in the high single digit range, but people who look at 11-year data might wonder if the anemic return on stock markets is worth the risk at all. Both conclusions are plausible. I suspect that, given the extremity of the experience, the likely outcome will fall somewhere in between those two assessments. Perspective remains vital. For my part, I moved clients to their target allocation in the middle of 2009 and have allowed most of them to drift to the positive in the following years. That changed in Q4 of 2017. Since then, I’ve taken a more neutral stance. Allow me to illustrate. As a Portfolio Manager, I have the discretion to manage my clients’ accounts with a 10% variance of a target asset allocation. Let’s say your target is 70% stocks; 30% bonds (70/30). In this scenario, I can be as aggressive as 80/20 or as conservative as 60/40 and still be fulfilling my fiduciary obligations of managing my clients’ accounts in their best interest. Portfolio Managers have discretion, but there are practical limits. They can’t wing it or freelance with risk profiles. For the almost 8.5 years from the summer of 2009 to the autumn of 2017, I generally took my time in re-balancing portfolios back to their target weights. As such, my clients frequently had a modest equity bias to their baseline portfolio position (i.e., at 70/30 portfolio might be 75/25 on any given day during that timeframe). Since late 2017, I have been steely-eyed in adhering closely to the target weight set out in my clients’ investment policy statements. In short, I’ve moved from a ‘risk-on’ to a ‘risk-neutral’ stance. I’m not really predicting anything in doing this, but I am expressing a view that the easy money has been made and that the risk-reward trade-off no longer warrants an equity bias. When I show people the 10-year chart, there tends to be a broad acceptance that that is indeed the case. John J. De Goey, CIM, CFP, FELLOW OF FPSC™ is a registrant with Wellington-Altus Private Wealth Inc. (WAPW). WAPW is a member of the Canadian Investor Protection Fund (CIPF) and the Investment Industry Regulatory Organization of Canada (IIROC). The opinions expressed herein are those of the author alone and do not necessarily reflect those of WAPW, CIPF or IIROC. Investors should seek professional financial advice regarding the appropriateness of investing in any investment strategy or security and no financial decisions should be made solely on the basis of the information and opinions contained herein. The information and opinions contained herein are subject to change without notice.

MORE BY JOHN DE GOEY:

Image by Alexas_Fotos from Pixabay

Comments Cancel reply

Ask a Planner

Can Canadian investors save tax when a stock’s company goes bankrupt?

You may be able to get some tax relief when the stock of a company you hold goes bankrupt....

Can Canadian investors save tax when a stock’s company goes bankrupt?

Canadian couple outside of home, wondering if they should transfer it to their corporation.

Ask MoneySense

Is transferring your principal residence to your corporation a good idea?

Would swapping a house for cash from a corporation save on taxes? And is this tactic worth it in...

Is transferring your principal residence to your corporation a good idea?

Ask a Planner

RBC’s discount broker launches international trading—what to know before you invest

It’s a first among bank-owned discount brokers in Canada. With more banks likely to follow RBC's lead, what should...

RBC’s discount broker launches international trading—what to know before you invest

Ask a Planner

What are the tax implications if you resell Taylor Swift tickets?

Allison resold her Eras Tour tickets instead of going to the concert. The resale website asked for her SIN,...

What are the tax implications if you resell Taylor Swift tickets?

Ask a Planner

Should you take extra RRIF withdrawals to increase your estate?

Contrary to the conventional advice, taking more than the minimum RRIF withdrawal can at times save tax on your...

Should you take extra RRIF withdrawals to increase your estate?

Ask MoneySense

How much income can I earn while getting OAS?

If you continue working in retirement, it could cause a clawback on your OAS. Here’s how to figure out...

How much income can I earn while getting OAS?

Ask a Planner

Estate planning for singles—is a trust company the answer?

Canadians with no children or siblings must consider estate planning alternatives. Here’s why trust companies can be a good...

Estate planning for singles—is a trust company the answer?

Ask a Planner

What to know as Canada’s capital gains tax changes remain in legal limbo

The federal government’s capital gains inclusion rate increase has yet to become law. There’s a slight chance it may...

What to know as Canada’s capital gains tax changes remain in legal limbo

Ask a Planner

How to report foreign income in Canada

Canadians have reporting requirements for foreign assets, income and tax paid. Here’s how to claim each of these on...

How to report foreign income in Canada

Ask a Planner

Should you invest an inheritance in an RRSP or a TFSA?

A Certified Financial Planner provides perspective on the TFSA vs. RRSP question for a couple in their late 50s...

Should you invest an inheritance in an RRSP or a TFSA?

Why having a short memory can hurt investment returns

MORE BY JOHN DE GOEY:

Comments Cancel reply

Related Articles

Can Canadian investors save tax when a stock’s company goes bankrupt?

Is transferring your principal residence to your corporation a good idea?

RBC’s discount broker launches international trading—what to know before you invest

What are the tax implications if you resell Taylor Swift tickets?

Should you take extra RRIF withdrawals to increase your estate?

How much income can I earn while getting OAS?

Estate planning for singles—is a trust company the answer?

What to know as Canada’s capital gains tax changes remain in legal limbo

How to report foreign income in Canada

Should you invest an inheritance in an RRSP or a TFSA?