A few years ago, I started going to a sushi restaurant a few blocks away that offered an all-you-can-eat buffet. It was my go-to venue for a great lunch deal – lots of sushi for a very reasonable flat price. So every few weeks, I’d settle in to my favorite table, gleefully ignore the (woefully overpriced) a la carte menu, and happily inform the waiter that I’d be having the buffet.
[schloss]
So about a month ago, I did the same thing, expecting the same result: Cheap sushi for lunch. But the waiter told me: Sorry, sir, we no longer have that promotion. And he nodded to the menu on the table.
I felt a wave of shock peppered with disappointment wash over me. Past experience had led me to expect that this time – like previous visits – I’d get the buffet. Why wasn’t it available? What was different now?
I assumed that what happened before… would continue to happen.
Sushi and markets
The recent correction in global markets was, in some ways, a shock for many investors. After all… for years, every day, they’d been getting the buffet. Global markets have been moving relentlessly up, with minor bumps along the way, since 2009. So why wouldn’t the buffet be available (markets continue to rise) in early February?
Of course… we know that no market goes up forever. Stock markets, currencies and commodities all rise and then they fall, and then they do it all again… and again. (Restaurant managers realise that they can’t forever feed hungry people endless sushi without losing money…)
And we’ve been warning that we’re nearing the end of the bull market for some time now. The signs pointing to the recent plunge were all there.
But despite this predictability, most investors were still caught off guard by these market cycles. A market was moving in one direction… and then the cycle moves on to the next phase and everyone is surprised. It’s such a shock because of “status quo bias”.
The status quo bias
We tend to think that things are likely to remain the same – because our most recent memory is of them being a certain way. Investors buy a stock that’s been steadily rising in price because they expect it to continue going up. Investors expect a bull market to continue because, well, the market has recently been rising. Status quo (which means “the state in which” in Latin) bias helps people forget about cycles.
Investors fall victim to status quo bias because they believe the four most dangerous words in investing: “This time it’s different.” This time, the market will continue going up… and this time the hot stock will continue to rise.
Of course, nothing is different. The cycle always prevails.
And as we’ve shown you before, the outperformance of the U.S. market can’t go on forever… due to mean reversion. Markets (along with most other things in life – like cheap sushi buffets) tend over time to reverse extreme movements and gravitate back to average.
It’s like a rubber band… stretch it and when you let go it returns to its original shape. So after a period of rising prices, securities tend to deliver average or poor returns. Likewise, market prices that decline too far, too fast, tend to rebound. That is mean reversion, and it works over short and long periods.
So how can you protect yourself against status quo bias?
It’s one thing to intellectually recognise that a cycle will end at some point. It’s another thing to do something about it.
It turns out that the best way to beat status quo bias is to procrastinate.
Studies on behavioral economics have shown that if asked to make a particular decision about something by the end of the day, people are more likely to decide to leave things unchanged. Change is hard, and the status quo is easy. And when you don’t allow yourself time to make a decision, it’s easier to keep things the same.
But when people are asked to make a decision by the end of the week, they’re more likely to think carefully – and make a decision based on facts, rather than the comfort of the status quo. This suggests change comes more easily if you have time to get used to it.
So if you still think “this time it’s different”… wait a bit. You may realise that, in fact, it’s not. If you’re not ready for a market correction, check out our crisis preparation checklist. And while you’re at it, get some of the best portfolio hedge advice available.
(But if you’re looking to drown your fear
