Yesterday, the S&P 500 closed at a new all-time high of 1569.19. That's awesome if you're looking at the short term. What about the long term? The ten-year annualized return for the S&P, as of yesterday, was 3.2% per year. Hardly anything to write home about. Right? Trouble is that we are all subject to confirmation bias. The non-technical, short-version definition of confirmation bias is that "we look for evidence to prove we're a genius, even if we're not".
Here is a very timely guest post from my friend, Carl Richards at BehaviorGap.com describing how this works:
"We love to tell ourselves stories. And when it comes to money, we’ve gotten really good at it. Those stories then lead us to do things that we wish, in hindsight, we hadn't.You know the stories. You may have even told them to yourself a time or two. You know when you hear them that somebody (maybe even you) is about to do something dumb with his or her money.Things like:
- I just can’t take it anymore. I’m going to sit out of the market until things settle down.
- It’s a perfect opportunity. I need to get in while I still can.
- Look at what the market’s doing. I can’t afford to do nothing.
When we get into storytelling mode, we often fall into the trap of confirmation bias. We start “discovering” all the reasons why we must be right and ignore the things that show we might be wrong.For instance, when you’ve taken the time to build a solid financial plan, you’ve probably added a rebalancing trigger. Let’s pretend that stocks shoot up and your portfolio’s overall value is suddenly 80 percent stocks.Now your plan calls for a 70/30 split between stocks and bonds. Because you’ve included rebalancing in your plan, you already know what to do---sell off some stocks and buy more bonds. But then you decide to tell a story.You take a look at the news. You take a look at your portfolio balance. Then you say, “Look at what the market’s doing. I don’t need to rebalance.” And just like that you’ve told a story that in hindsight is going to make you wish you’d stuck with your plan. It will be particularly painful if it reaches a point where you decide it’s time to tell another story: “I just can’t take it anymore.”And that’s the point. Once we start telling stories, it can be really hard to break the cycle. Then the longer it takes to break the cycle, the more mistakes we’re likely to make and the more we’ll have to regret. So while I love a good story as much as the next person, maybe we can’t afford to keep telling stories that distract us from our plans."