Avoiding Extremes - A Clear Eyed View of What's Really Going On

Avoiding Extremes – A Clear Eyed View of What’s Really Going On

Avoiding Extremes - A Clear Eyed View of What's Really Going On

I'm wishing you all a Happy New Year, and want to start the year by sharing our 2018 Year-End investment letter, and some advice around avoiding extremes when it comes to behavioral investing. Let's start with a hypothetical quote:

What if Charles Dickens had begun his classic “Tale of Two Cities” as follows:

It wasn’t the best of times, it wasn’t the worst of times, it was the usual mixed bag.

While the statement may reflect reality, it doesn’t grab your attention half as well as Dickens’ actual opening sentence describing the French Revolution. As he concluded about the period,

“some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

Thus, we’ve long known about our infatuation with extremes – Best! Worst! Delight! Despair! These are the sentiments that fuel our dreams and inspire our works of art. But you do yourself a disservice if you allow superlatives to rule your investing.

In capital markets, if you get caught up in extremes and devalue the sweeping tides of time, you risk giving up your greatest edge: a clear-eyed understanding of what’s really going on.

Two evidence-based points from 2018

As we reflect on the events of 2018, here are two evidence-based points worth repeating:

1. “Average” annual investment returns aren’t typical; in fact, they’re rare.

Avoiding extremes and looking for averages
Averages should be seen in the grand scheme of things

To quote a more contemporary source than Dickens, Cliff Asness of fund manager AQR recently observed: “This world is pretty much designed to convince us that we’re always at DEFCON 1, when 5 is the mode and 4.5 the mean.”

Other year-end analyses concluded that market volatility for 2018 remained on the low side. Even the wilder swings toward year-end were not that remarkable in the grand scheme of things. Avoiding extremes in financial decision making should be seen in this context.

Superlatives can be a two way street

And yet, many “noisiest authorities” have been quick to play up the superlatives, while downplaying how these sorts of best of times, worst of times conditions have long been more the norm than the exception in capital markets. As expressed in this Forbes column,

“when you take the long view – and if you’re a long-term investor, then you should – you’ll see that what feels jarring right now is actually just a return to normal levels of short-term volatility.”

This brings us to our second point.

2. You are human; you are susceptible to recency bias.

Recency bias can trick your brain

While there are many behavioral biases that trick us into sabotaging our best financial interests, we’re especially interested in the damage recency bias could cause in current conditions.

Recency bias can trick your brain into downplaying decades of robust market performance data, while magnifying the run of unusually calm market conditions we’ve been enjoying relatively recently – essentially since March 2009. This in turn may lead you to lend more weight than is warranted to current volatility.

Should we be avoiding extremes, even when they might be the norm?

That’s not to say the ride will be fun if we encounter more turbulence ahead. But by remembering extremes are actually the norm in your quest to generate durable long-term returns, you stand a much better chance of preserving your objective perspective and your portfolio, come what may.

We are grateful for the opportunity to remain at your side, ever eager to advise your course through whatever the markets have in store for us in 2019 and beyond.

How can we help? Let us know!

Our Evidence Based Guide To Behavioral Investing

I mentioned recency bias in this post. Our own biases can be the greatest threat to our financial well being. If you have not downloaded our behavioral investing guide, start your 2019 investing decisions the right way:

Learn about 17 common investing biases that could be hurting your financial decision making right now.

Avoiding extremes starts with avoiding biases
Learn to avoid 17+ common investing biases

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About the Author Doug Finley

Douglas Finley founded Finley Wealth Management, a Fee-Only Registered Investment Advisor, with the goal of creating a firm that eliminated the conflicts of interest inherent in the financial planner – advisor/client relationship. The firm specializes in financial planning and investment management for high-net-worth individuals and families.

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