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Trying to Avoid the "This Time Is Different" Mentality

hand watch time
“The more things change, the more they stay the same.”
– Jean-Baptiste Alphonse Karr

We have all said it before. Whether it comes to our finances or any situation that involves what seems like a high degree of uncertainty, we are all predisposed to believing that our current situation is something we have never faced before. In all actuality, it is usually not as bad or as different as we want to think.

This is prevalent, I believe, because of our inability to consistently remember or relate to events that have taken place beyond the most recent past. Behavioral scientists often refer to his phenomenon as recency bias. Long story short, we are pretty bad at accurately recalling events that haven’t happened in the last few weeks, months, or years and we allow events that have happened most recently influence how we behave.

The human tendency of recency bias highlights the importance of history as an academic discipline. It allows us to record events as they take place in order to accurately recount some of our most important events of the past. From an empirical perspective, history also allows us to quantify the events of the past through the use of data in order to give us guidance for the future.

In my world, history plays an important role in providing guidance to investors on how to approach the capital markets. Simple rules of statistics tells us that the most accurate estimate of a random variable is the historical average and since markets have been proven to move in a random fashion, our best estimate of its expected return is always the historical average. Believing this is not the case means we are attempting to predict the future, which nobody can do consistently and with a high degree of precision. 

Nonetheless, we still want to believe that our current circumstance is beyond the realm of anything that we have ever faced before. It is going to be a bigger economic depression, or a more costly war, or a much riskier presidential candidate. Tying ourselves to this belief that "this time is always going to be worse than the previous" is reallhy a defense mechanism in order to protect us against risk, uncertainty, or potentially harmful events. It's in our DNA. 

What is important to understand is that this mentality can really be seen as analogous to gambling. I define gambling as taking risk in order to seek an outcome that is better than what is expected to happen. In other words, you are simply playing the odds and odds are not in your favor.

Now gambling can be seen as fun when it comes to a weekend in Las Vegas, but the stakes are much different when we apply the same principles to our life savings. When we faced the last financial crisis in 2008 and 2009, many investors and professionals alike believed that “this time was different.” And while we did experience one of the biggest declines in the market since the Great Depression, we also saw a rebound that rewarded the disciplined investor. In fact, if we look at the annualized return over the last 10 years, which of course includes the Great Recession, for IFA Index Portfolio 60, we will see a return of 4.81%. This 10-year period is not even considered a “left-tail” (i.e. extreme) event as it doesn’t even fall into the worst 2.5% of 10-year historical performances we have ever witnessed. See chart below.

Click to see the full interactive IFA Index Portfolio chart

Believing “this time is different” is really just another form of gambling. It helps us cope with the uncertainty that we currently face without acknowledging its similarity to events that we have already faced in the past. History can act as guide in not only educating us about events of the past, but also quantify what we expect to happen in the future. There is the real risk that this time could be quite different, but as long as the capital markets stay competitive, prices will always reflect the positive expected return that investors demand on the capital they provide. 

 

On a related note, see this video from 2012: