I was born and raised in landlocked South Dakota. If I had a dollar for every time someone told me, “I’ve never met anyone from South Dakota,” I believe I could comfortably retire.
I was 20 before I saw the ocean for the first time. But today I live in Quincy, Massachusetts, just south of Boston and my house is a couple of blocks from the ocean (technically Quincy Bay). I can see it from my topmost window. I look at the water from that window nearly every day, and many days I walk near the water.
Even though I’ve lived here for nearly 20 years, I still marvel at how different the water looks from day to day and season to season. Sometimes even within a day the appearance of the water changes dramatically.
When the sky is overcast, the water looks slate grey. If it is windy, there are whitecaps and in big storms the waves crash against the sea wall. In contrast, on cloudless days the water looks deeply blue and can sparkle like diamonds.
Sometimes on a perfect summer afternoon when I look at the blue sparkly water I have a tough time remembering the grey color, let alone whitecaps or crashing waves. And yet it might look like that the very next day.
Similarly, when the stock market is steadily climbing, it can be hard to imagine a bear (bad) market. And when the stock market is steadily declining, it can be hard to imagine the bull (good) market will return. Recent research confirms that investors’ stock market forecasts are simple projections of the recent past into the future. In other words, when the market is doing poorly, we predict it will continue to do so. When it is doing well, then our forecast is more of the same. This common tendency is called the “recency effect” and it can wreak havoc on your portfolio.
If you act on your prediction that the bull market will continue and change your asset allocation to buy more stocks, you may get burned when your prediction does not come true and stocks go down instead.
The opposite is also true: at what might be the bottom of a bear market, you may decide stocks will continue to fall forever and sell. In both these cases you bought high and sold low. Exactly the opposite of how you make money with investments.
The trick is to have a plan, stick with it, and change allocations only when circumstances in your life warrant it. Not in response to market gyrations. This is where having an advisor is critical. An advisor is an objective third party who helps you stay the course when emotion gets in the way. As the great investor Benjamin Graham wrote: “The investor’s chief problem – and even his worst enemy – is likely to be himself”.
Authored by fellow Alliance of Comprehensive Planner (ACP) member, Michelle Morris, CFP®, EA. Alliance of Comprehensive Planners