Do not invest by looking in the rearview mirror.

Feel free to reach out to PSG Wealth Manager  Patrick Duggan  directly.

My observation of my friend’s tee shirt reminded me of current conversations with many of our clients where the following two topics keep popping up.

• Performance expectations given two good years of performance; and
• The outperformance of ‘Passive’ vs. ‘Active’ money management.

Volatility: The Investor’s Forgotten Friend

Investment markets have been very kind to global equity investors over the last two years. After a period of sideways markets and soaring inflation, the S&P 500 (the world’s premier stock market) rose by 24% in 2023 and another 23% in 2024.

With historical average returns in the 8-10% range, these are extraordinary returns that patient and disciplined investors will be delighted with.

Most significantly, the last two years saw no extended periods of significant declines.

In 2023, the largest decline was -10% between July and October. In 2024, the worst was a 21-day decline of only -8% between July and August.

While this was a welcome respite from the normal market rhythm, the financial media would have been dismayed! More seriously, there is a danger that investors will forget the important lessons learnt from past declines.

To prepare you for the possibility of more significant declines in the coming year, we outline a few points below that you should keep in mind when others are losing theirs.

What You Should Know

It is a feature of the stock market that values do not move in a straight line but instead fluctuate around an upward trend. We refer to this as “volatility.”

A market correction is defined as a 10% drawdown from a previous market high. While it may sound like a significant number, these events occur far more frequently than most investors believe. Indeed, they come around as often as your birthday, with years like 2024 being the exception.

Since the turn of the century, the average annual decline has been approximately -16%. While this may surprise you, it is worth noting that about three in four years it still ended with a positive return.

We also know from market history that we expect a decline of more than -30% every five years (on average), as we last experienced in 2020.

How You Should React

We know that stock markets provide positive returns about three in every four years. The one negative year is what earns you the other three positive years. It is the price of admission for profiting from the collective ingenuity of the hundreds of companies working for you while you sleep. We encourage you to see the temporary declines as the reason for the stock market’s permanent returns. You cannot have one without the other.

Unfortunately, we cannot consistently predict when these fluctuations will occur or when they will reverse. To be a successful long-term investor, one must accept this with humility.

Market declines will consistently occur throughout your investing life, and your mindset during these times is a choice that will shape your financial future. We advise you to confront them with confidence rather than fear while being mindful of the opportunities they present.

Time Heals

What happens in the next year is unimportant to your 30-year plans. If you are investing long-term, the odds are stacked in your favour. You are guaranteed to win.

After two years of little volatility, if we experience a decline in the coming months, be encouraged that you are busy earning future returns.

Additionally, if you are still saving, declines are your best friend, allowing you to buy more units of shares at reduced prices.

While we do not know where the market will be at the end of 2025, we are confident about where it will be in 10 years: much higher. Time is the enemy of market declines, and most investors have plenty of time.

‘Passive’ vs. Active’

NB. The following is not an argument for/against either approach to money management - for that, there are many articles one can find through a simple Google search and I for one personally do not feel that the ‘argument’ for one over the other needs to be binary.

“Passive investing is putting your vehicle in reverse gear and looking through the rearview mirror and reversing to where the value was, not where the value is going to be tomorrow” Hendrik du Toit (Founder and CEO of Ninety One).

Hendrik’s thoughts aside, it is well understood that the current trouble with especially a ‘vanilla’ route to ‘Passive’ investing, predominantly to buy a simple market capitalisation weighted global equity index tracker fund or an exchange-traded fund (e.g. MSCI World) is the enormous concentration risk within these vehicles to a single geography (the US, e.g. S&P 500) and within the US, to a single sector, (Technology) which sector is what has driven the outsized returns of the past several years, and especially over the past two years as these two charts from Coronation illustrate.

Once again, my objective is not to get into the weeds on the technicalities of market inefficiencies as defined by valuations, earnings, etc., but to suggest that investors need to be aware of recency bias.

The extract below on recency bias is from Investopedia.com.

Recency (Availability) Bias: What it is and how it works.

 In behavioural economics, recency bias (also known as availability bias) is the tendency for people to outweigh new information or events without considering the objective probabilities of those events over the long run.

Availability bias matters for the financial markets, as a memory of recent market news or events can lead investors to irrationally believe that a similar event is more likely to occur again than its objective probability. As a result, investors may make decisions to sell into bear markets, or buy into bubbles, since crashes and bubbles can be salient in the minds of individuals as they occur.

Understanding Recency (Availability) Bias

A well-known example of recency bias is that people tend to overreact to news of a shark attack that has recently occurred. Shark attacks, especially deadly ones, are extremely rare killing just a handful of people each year. In 2023, for example, there were only sixty-nine reported unprovoked shark attacks worldwide. Nevertheless, many fewer people swim in the ocean following reports of a shark attack, with many people believing the odds are far greater than they are. Indeed, after the 1975 blockbuster movie Jaws came out, the notion of an unprovoked shark attack became incredibly salient, leading to far fewer swimmers than in previous years.

For investors, availability bias affects the trading decisions that people make based on recent events or headlines, expecting such events to be more frequent than they are. During a market crash, people may adopt a negative outlook that assumes a bear trend will continue, even though the drawdown may merely be a correction. On the other hand, during asset bubbles, when prices reach levels that are no longer supported by fundamentals, people may continue buying under the false belief that the rally can only continue.

Correcting Recency Bias

Recency bias can be difficult to counteract because it plays on human emotions of fear and greed, which are powerful forces. Moreover, our brains are wired to put the most emphasis on recent events that are fresh in our memories as older events fade out of our mind.

For investors, the best way to combat recency bias is to have an investment strategy and stick with it, regardless of short-term market volatility. Plan how and when to rebalance your portfolio and when to reevaluate your long-term investment allocation. Of course, this is often easier said than done, as people may become overwhelmed with the impulse to take some action based on current events.

Example: The ‘Hot Hand’

One example of recency bias is in the case of the “hot hand,” or the sense that following a string of successes, an individual is likely to continue being successful. This was first identified in the sport of basketball (hence the hot hand), whereby players who have scored several baskets in a row are thought to keep scoring. As a result, players may pass that person the ball more often, even though their actual performance may not be above average.

In the markets, investors are similarly tempted to invest with fund managers who have recently outperformed the market over the course of several years, feeling that they, too, have the hot hand. Portfolio managers who have had an unusually long winning streak often underperform their peers in future years.

Availability bias of the hot hand can even come into play when outcomes are independent of what has happened before, such as flipping a coin or the roll of a die. In this case, the bias takes on the form of the gambler’s fallacy, whereby people believe that a random event is more likely to occur just because it has in the past—or, alternatively, that it is likely to occur because it has not happened recently and so it is “due” to hit (even when the probabilities remain exactly the same per roll, spin, or flip).

Therefore, for the investor simply looking to buy what has worked well most recently, our message is to be aware of recency bias and importantly to be aware of what you are buying.

“I skate to where the puck is going to be, not where it has been.” Wayne Gretzky

One way to help ensure a hands-off approach and to remove emotion from trading decisions is to talk to your Wealth Manager.