Monday, December 19th, 2016
“Recency bias and sticking with diversification”
There are many cognitive biases in the human mind that impact behavioral tendencies to investing. One example,
recency bias, is the tendency for individuals to put more weight on the recent past and extrapolate those trends as
likely to continue into the future.
This recency bias often impacts portfolio allocations and the tendency for investors to chase returns from asset
classes that have performed the best most recently and avoid those that have performed the worst. Ironically, the
optimal decision for maximizing investment return is often just the opposite.
Most recently, it has become easy to benchmark portfolio performance vs. the U.S. stock market returns. After all,
that is the most commonly cited benchmark for U.S. investors when turning on the TV or picking up a newspaper.
It just so happens that the U.S. stock market has also been the number 1 global equity market since March of 2009.
Entering 2010, many investors considered the 2000’s (2000-2009) to be a “lost decade” for stocks. However, as the
other table above shows, although U.S. large cap equities (S&P 500) had negative returns during this time period,
many other asset classes provided strong annualized returns. The value of diversification never felt so worthy.
Since that time, the tables have turned quite dramatically. U.S. equities have dominated their international brethren
over just about time horizon since March 2009. That performance gap has materially increased over the last 12
months. Emerging market stocks have had a bounce back year, coincidentally when investors started to give up, but
the returns over the last five years are still very sub-par in comparison to the U.S.
Region
U.S.
U.S.
International
Emerging Markets
Annualized Total Return hrough 12/16/16
Index
1-Yr
5-Yr
Since March '09
DJIA
14.84
13.67
16.42
S&P 500
11.34
15.56
17.10
MSCI EAFE
0.29
4.38
6.62
MSCI EM
8.36
-1.08
5.62
Source: Morningstar
With the recent dominance of U.S. equities over other asset classes, and the animal spirits of investors pouring into
U.S. equities since the election, the temptation to give up on international and emerging market stocks seems to be
increasing. That can be evidenced partly on how investors are voting with their dollars. Last week, Eric Balchunas,
a Bloomberg ETF strategist reported that 91% of all ETF flows in 2016 went to U.S.-focused products vs.
international. Last year that number was 50%.
This could be another case where recency bias forces investors to give up on asset classes that may contribute to a
diversified portfolio over a full market cycle. Just as investors were so easy to give up on U.S. equities at the peak
levels of pessimism during the financial crisis of 2008-2009, the levels of optimism can exceed relative valuations
and forward-looking opportunities after recent periods of outperformance. The U.S. has certainly been the cleanest
shirt in the dirty laundry basket of global growth, but that may not always be the case.
For those interested in learning more about human psychology and how tendencies in decision-making impact
investor behaviors, we would recommend you check out Daniel Kahneman’s Thinking Fast and Slow.
Jack Holmes, CFA® & Todd Feltz, CFP®
WealthPLAN Partners
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. Information is based on sources believed to
be reliable, however, their accuracy or completeness cannot be guaranteed. Statements of forecast and trends are for informational purposes, and are not
guaranteed to occur in the future.
All indices are unmanaged and may not be invested into directly. The Barclays Global Aggregate Index measures global investment grade debt from 24 local
currency markets. The Standard & Poor’s 500 index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic
economy through changes in the aggregate market value of 500 stocks representing all major industries. The Dow Jones Industrial Average (DJIA) is a priceweighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
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