STREET DOGS

HOURS after Pearl Harbor was attacked in 1941, the US military planted mines in San Francisco bay. Trenches were dug along the West Coast. The idea that Japan would follow up with an even greater attack on the mainland wasn’t if but when. Same thing after 9/11 — everyone from policy makers to intelligence officials to lay Americans warned that an impending second attack was nearly certain. Something similar happened after the financial crisis. The idea that we’d soon get hit with a new financial crisis and double-dip recession was taken as nearly certain. But five years on, it hasn’t come. Preparing for the worst is better than the opposite, but we consistently fool ourselves about the recent past foretelling the future. Psychologists call it recency bias.

Recency bias is pretty simple. Because it’s easier, we’re inclined to use our recent experience as the baseline for predicting the future. In many situations, this bias works just fine, but when it comes to investing it can cause problems.

When we’re watching a bull market run, it’s easy to forget about the time that it didn’t.

Recent memory tells us the market should keep going up, so we keep buying, and when it doesn’t we’re surprised.

When the market is going down, we forget that this is temporary too and that it will eventually go back up. But then one day it does — sometimes far quicker and much higher than we could have imagined — and we’re left sitting with a pile of cash, earning next to nothing.

The point isn’t that you should have predicted the bubble or the upswing, but that you should have considered both possibilities and planned accordingly. Instead of taking the long view, we settle into a rut and don’t see the need to get out of it.