"Shark Week" is an annual installment of programming on Discovery that will be airing from July 23 to July 29 this year. The famous great white shark from 1975's summer hit "Jaws" by Steven Spielberg can be used as an example when discussing an important concept to investors - "recency bias," or giving too much attention to recent occurrences, such as a stock market decline, when making investing choices.
With the return of Shark Week, the annual television event showcasing the ocean's most feared predators, the famous man-eating great white from "Jaws" can teach investors an important money-saving lesson. This lesson is known as recency bias, a tendency to become swept away by fear or euphoria of the past. Recency bias is usually accompanied by financial loss and is caused by over-emphasis on recent events such as a stock-market crash, the skyrocketing of bitcoin, or meme stocks like GameStop. Charlie Fitzgerald III, a certified financial planner from Orlando, Florida explains: "People need to be aware that recency bias is natural and instinctive, a survival tactic."
Despite logical reasoning that encourages investors to plan long-term, emotions can often interfere and lead to unfavorable decisions - like selling stocks due to a fear of the unknown. This is known as recency bias and is similar to the irrational fear that follows watching Steven Spielberg's horror classic "Jaws" and being hesitant to even dip your toes in the ocean. Omar Aguilar, CEO and chief investment officer at Schwab Asset Management, astutely noted that "the actual risk of being attacked by a shark is infinitesimally small." Fitzgerald, a principal and founding member of Moisand Fitzgerald Tamayo, described the impulse of recency bias in a more intuitive way - "If I get stung by a bee once or twice, I'm not going to go there again. The recent experience can override all logic."
An example of this can be seen in the financial services sector from 2019 to 2020. In 2019, the S&P 500 Index saw a 32% increase in returns due to this sector, leading to some investors investing heavily. However, in 2020, returns for the sector dropped by 2%, while the S&P 500 overall had a positive 18% return. As Aguilar pointed out, this would disappoint those who had invested in financial services stocks.
Financial experts provided several examples of how recency bias can be a problem for investors, such as when investors tilt a portfolio more in favor of U.S. stocks after poor performance in international stocks, or make buying decisions based solely on a mutual fund's recent performance history. Aguilar believes this kind of short-term market behavior can interfere with long-term objectives, like reaching financial goals. Fitzgerald sees it as a form of fear of loss or "fear of missing out" (FOMO) that comes from market behavior, and trying to time the investment markets from this impulse can always have negative results, typically leading to buying high and selling low. Recency bias becomes especially dangerous during major life events, such as retirement, when market conditions can appear to be unnerving.
Long-term investors who have their investments spread across multiple asset classes can be confident that they will be able to weather any storms, rather than panic sell. An example of a well-diversified portfolio typically has exposure to the stock market including large, mid, and small-cap stocks, foreign stocks, and possibly real estate. Additionally, the portfolio should also contain short-term and intermediate-term bonds, and a small amount of cash.
Investors who want a wide range of market exposure can obtain it through buying low-priced index mutual funds or exchange-traded funds that track different sectors. Alternatively, they can also invest in a single fund, such as a balanced fund or target-date fund. The proportion of stocks and bonds in a person's portfolio tend to be determined by factors such as his/her time-frame, capacity and willingness to take risks; for instance, a young investor who plans to retire in thirty years' time may have around 80-90% of his/her investments in stocks.
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