Foster Group

Could you be at your peak effectiveness regarding financial decision-making right now?  It’s quite possible you are very near that point, if we accept a couple of ideas about how our brains function.

Since October 2007, most investors have seen the value of their portfolios decline precipitously (global stocks lost 53% between October 1, 2007 and February 29, 2009) and rebound dramatically (those same global stocks have risen 69% from March 1, 2009 through March 31, 2010 **).  So, while portfolio values are likely still well below those peak 2007 values, they are likely well above their early 2009 lows.

Sitting here with your coffee (or tea) on April 1, 2010, which experience - the big drop or the rapid rebound - is having the most influence on your thinking and actions today?

“Recency Bias,” an accepted psychological phenomenon, would lead us to conclude that the most recent events (rapid rebound) would likely leave the strongest impression.  But University of Oregon Professor Paul Slovic observes that another aspect of our brain function means, “it takes far more good news to build our confidence than it takes bad news to destroy it”.  He goes on to say that, “In the past few years, we’ve seen a lot of things that caused us to lose faith in the institutions that we would like to be able to trust.  These feelings tend to override our ability to analyze things in a logical way.”  (As quoted in the April 2010 edition of Money Magazine).

By acknowledging both influences on our thinking, we may be entering a unique opportunity for good thinking and decision making.  Our tendency toward Recency Bias as we look at the strong market returns of the past 13 months - which could lead us into feelings of overconfidence and greed - is being tempered by our tendency to hold onto negative experiences too long and project those feelings forward indefinitely.  Perhaps we are at a balancing point, moving away from fear but not yet to overconfidence.  This would be a very good place from which to make sound, long-term financial decisions.  This balance is achieved not by forgetting the extreme experiences of the past 2 years, but by clearly looking at them together, and making decisions we can live with, knowing that we will likely go through many more short-term boom-and-bust cycles in investment markets.

So, if you’ve been wondering when to revisit your portfolio balance between stocks, bonds and cash, or how long you may need to work to realistically achieve your long-term lifestyle expectations, perhaps now is the ideal time for assessment and taking action.

**  As measured by the MSCI AC World