Recency Effect: The regular obsession on every passing data point is a reflection of the way you humans experience the passing of time. You tend to focus on what just occurred, often to the detriment of the bigger picture or the longer-term trend. We see this in the focus on what I call “recession porn” -- every negative news story or idiotic appearance of the Hindenburg Omen. Post-traumatic stress disorder affects not only soldiers but the investing public as well. Post-Crash Stress Disorder -- PCST -- is the likely reason so many investors have been carrying so much cash during a 150 percent rally. They are waiting for the next crash, having missed the last one.
Politics: Whenever I give a speech on behavioral economics, I like to show two charts: the rallies off of the 2003 and 2009 lows. My friends who are Democrats told me how awful the George W. Bush tax cuts were -- they weren’t going to create jobs, would blow out the deficit, etc. To paraphrase someone else’s line, give me a trillion dollars and I will throw you a hell of a party. The market nearly doubled, and all of these guys missed it.
Before my Republican friends start smirking, let me remind you that few years ago you were insisting that Obama was a Marxist Kenyan who was about to (in the words of an infamous Michael Boskin WSJ column the very day of the low) destroy the Dow. A market that has gone up more than one and half times since then should not only wipe that smirk off your faces. It should make any investor from either party swear off politics.
Cherished Myths: There are so many myths about investing that are not verified, not tested, not supported by evidence, that it is astounding anyone puts money to risk based on them. How has that Death Cross been treating you? “Sell in May” work recently? Quasi value investing by buying single-digit P/E stocks -- how’d that work with home builders in 2005, banks in 2006 or investment firms in 2007?
Blind Faith: Before you believe anything you read -- including any blather penned by yours truly -- you should do some homework. Look at the long-term track record, the methodology involved, the overall approach. Trust but verify was a good strategy when dealing with the Soviets, and a better strategy for investors is less trust and more verification.
The New Year is almost upon us. Now is a good time to think about what errors you may be making, and what you can do to repair them. There is never a better time than the present.
Your investors will thank you.