THE STOCK MARKET this year reminds me of one of those Rorschach inkblot tests. The broad U.S. market has gained more than 4%, including dividends, but it’s difficult to know what to make of it. Bulls point to this year’s tax cuts and believe that the market’s gain makes complete sense. Bears, on the other hand, note that the market has quadrupled in less than 10 years and conclude that it’s at an unsustainably high level.
In other words, it’s very much in the eye of the beholder. At times like this, we can be susceptible to biases in how we think—and that can impact how we respond. Below are three common investor biases, along with some recommendations for how to manage them:
Availability Bias. The internet today gives us access to thousands of economic statistics and market indicators. But no one—even a fulltime investor—has the time to sift through all this data. As a result, we tend to rely on the information that’s most readily available or that comes to mind most easily. While the information might be correct, the danger is that it’s also incomplete.
Recently, for example, when the government announced that unemployment had hit a multi-decade low, The New York Times reported, “The current economic expansion is already one of the longest on record, and there is no sign that it is losing steam.” CNN put it in these enthusiastic terms: “The last time the roaring American jobs market was this strong, astronauts were still going to the moon.”
But on the same day, the Tampa Bay Times ran an article headlined, “As corporate debt rises, so do worries about it triggering the next recession,” and cautioned that, “By some measures, companies have more debt than at any time in history….” Depending upon which of these stories happened to cross your desk, you might reach very different conclusions about the economy’s health. That’s availability bias.
Confirmation Bias. A close cousin of availability bias, confirmation bias occurs when you already have a point of view on an issue and then place disproportionate weight on data that supports that existing view, while downplaying data that doesn’t support it. Today, market bulls would cite record high corporate profits, while bears would point to market valuations that are, by some measures, at near-record levels. Both facts are accurate—and yet, thanks to confirmation bias, people on both sides of the debate will find their views reinforced.
Recency Bias. In New York yesterday, it was 60 degrees. If I asked you to forecast how hot it’ll get today, you would probably make a guess somewhere in the neighborhood of 60 degrees, and that would probably end up being about right. In many realms, it makes sense to extrapolate from recent data and assume that current trends will continue.
When it comes to the economy and the stock market, however, that doesn’t work. In fact, there’s an old joke that economists have predicted 15 of the last 10 recessions. Despite our best efforts, no one can reliably predict when the next bump in the road will come or what it will look like.
Investing, I believe, requires a constant balancing act. Yes, you want to be aware of where the economy stands and what the market is doing. But you also want to work hard to avoid letting biases cloud your view. On top of that, you want to keep in mind that all the data in the world still present a picture that’s incomplete. As the investor and author Howard Marks notes, “much of risk is subjective, hidden and unquantifiable.”
The bottom line: I believe that the most productive step you can take at this point, while the market is still near its all-time high, is to check and recheck your asset allocation. Even if you have a view on the way things will turn out, make sure you’ll be okay if it goes the other way.
Adam M. Grossman’s previous articles include Stepping Back, When to Roth, Not for You and Off Target. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.