As a regular viewer of Match of the Day, I'm often struck by how managers can remain so composed when interviewed after a defeat. They may have every reason to lose their cool like Kevin Keegan famously did in a post-match rant in 1996, and yet they generally manage to stay remarkably level-headed. (1)
So how are they able to do it? The main reason is that Premier League clubs now employ behavioural coaches to work with managers and players. Clubs realise the importance of maintaining psychological focus throughout the season and taking inevitable setbacks on the chin, whether that’s losing in the final minute or being on the wrong end of a controversial VAR decision.
Investors too can benefit from behavioural coaching. In the markets, as in sports, the prevailing mood can change very quickly. Share prices can steadily rise for months and then suddenly fall sharply. Luck, both good and bad, also plays a part. You may, for instance, invest your annual bonus or a small inheritance in the stock market the day before a sharp correction, but the next time you do it you might just catch the start of a bull run. The important thing is to keep your focus on your long-term goals and to resist the tendency to let recent or current events lead you to make irrational decisions.
The recency effect
Behavioural psychologists call this phenomenon recency bias, or the recency effect. The term refers to our tendency to give more weight to the most recently presented information than information presented earlier. Other examples are the way that people stop flying after a plane crash or take out earthquake insurance immediately after an earthquake.
It’s perfectly natural that we display these behaviours. It’s the way our minds, and particularly our memories, have evolved. For early humans, recent observations about weather conditions, predator movement or the availability of resources were crucial for survival. The recency effect would help to prioritise this fresh, and potentially critical, information.
The problem is that, when it comes to investing, our tendency to focus on recent events and what’s happening right now can be very unhelpful. Why? Well, the simplest and most reliable way to invest is to have a broadly diversified portfolio and benefit from the miracle of compounding by holding it for a very long time. All the evidence tells us that chopping and changing our portfolio and jumping in and out of the market, reduces our eventual returns. Recent and current events contract our time horizon and tempt us to act in ways that might give us short-term comfort but which we will probably come to regret
What, then, can we do about the recency effect? Here are five suggestions.
1. Read some financial history
If you’re investing for 20 or 30 years or more, you are bound to experience severe market downturns. About once in a generation, markets suffer a catastrophic reversal, with share prices falling 40% or more. So develop an appreciation of financial history and the ebbs and flows of the markets. Prepare yourself mentally now for when those downturns arise.
2. Have a plan for periods of volatility
Decide in advance on how you’re going to deal with market volatility whenever it strikes. Almost always the best course of action will be not to do anything. You could even write a memo to yourself, or record a video, to remind yourself when markets fall about the danger of doing something simply to provide emotional comfort.
3. Compartmentalise your portfolio
Think of your portfolio as having two distinct components. The first contains your risky assets, principally equities; the second includes much safer assets such as cash or government bonds. Tell yourself that you won’t even touch the risky part for a very long time and that it doesn’t matter if markets crash because your investments will have plenty of time to recover.
4. See the bigger picture
There are always reasons for investors to be nervous. Similarly, you’ll always find plenty of exciting investment “opportunities” to consider. But most of what we read about investing and the financial markets isn’t helpful information we should act on; it’s just noise. The key is to refrain from zooming in on tiny details, and instead to zoom out and take the long-term view.
5. Hire a behavioural coach
There are several reasons for hiring a financial adviser, but perhaps the most compelling one is that the behavioural coaching a modern adviser can provide can substantially improve your investment returns. Having someone who understands your behavioural biases and whom you can turn to if you’re feeling anxious is extremely valuable.
Does it ultimately matter?
A final point to reflect on is this: will whatever you’re worrying about today be anything so important, say, in five years? The chances are you’ll have forgotten all about it. Most investors waste too much time and energy worrying about things that ultimately don’t matter.
Whenever you feel anxious about your investments, the key is to acknowledge your emotions and ask yourself whether they’re telling you anything useful. Most of the time, the best response is to stay calm and not react.
So start thinking like a Premier League manager. That bad result today may have been painful, but it’s only one game, and fretting about it won’t make any difference. It’s how you’re feeling at the end of the season that really counts.
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
Robin Powell is a journalist, author and editor of The Evidence-Based Investor.
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