I imagine many of you have heard the story of the Blind Men and The Elephant.\u00a0 I believe it may have been the sixth grade or so when I was first introduced to it.\u00a0 This story originated in the Indian subcontinent but gained worldwide popularity after John Godfrey Saxe, an American poet, created his own version.<\/p>\n
\u201cOnce, 6 blind men were asked to describe an elephant. The first one touched its side and described the elephant like a wall. The second one touched its tusk and said it was a spear. The third one touched its trunk and described it a snake. The forth one touched its knee and called it a tree. The fifth one touched its ear and said it was a fan. Finally the last one touched its tail and described the elephant as a rope.\u201c<\/p>\n
Notice that none called the elephant an elephant. Why is that?\u00a0They were actually all correct from their own perspective, but each perspective led to an incomplete understanding.\u00a0They all described the elephant differently.\u00a0 Their descriptions were simply based on the part of the elephant they touched.<\/p>\n
Let\u2019s consider the stock market as the\u00a0elephant\u00a0<\/em>and investors or participants in the market as the\u00a0blind men.<\/p>\n Often investors view their stock market portfolio performance from a current or recent results perspective.\u00a0 This can lead to an incomplete understanding and this phenomenon actually has a name. This phenomenon is termed \u201cRecency Bias\u201d or \u201cThe Party Effect.\u201d<\/p>\n Consider a simple but extreme example of two clients that work with the same investment adviser. The first client joins the adviser in June of 2007 and bought into the adviser\u2019s recommended portfolio, which happened to resemble the S&P 500 index.\u00a0 The S&P index in June of 2007 was approximately 1531.\u00a0 The second client joined the adviser in November of 2008 and invested in the same portfolio.\u00a0 The S&P index was approximately 969 at that time.<\/p>\n The two clients attended a 4th<\/sup>\u00a0of July party in 2009 together and were talking with several mutual friends about what they thought of the stock market and their adviser.\u00a0 I\u2019m sure you can see where this is leading.<\/p>\n Client 1 thought the market was way too dangerous and that the adviser is not worth the money paid him.\u00a0 This adviser had managed to lose him almost 17% of his original investment as the S&P index was currently hovering around 1276.\u00a0 Client two, on the other hand, thought the adviser was the smartest market guy he had ever met and loved the stock market because his portfolio was up 32% from his original investment.<\/p>\n From this example, can you see where the Party Effect and the Recency Bias got their names?\u00a0 Just like the blind men and the elephant, the clients at the party had different perspectives since they experienced limited and different aspects of the stock market.\u00a0 Their descriptions were correct, but didn\u2019t incorporate a full understanding.\u00a0 And note the Recency Bias.\u00a0 Both clients had strong options of the adviser and the market based on their recent experiences, and these recent experiences will no doubt influence their thinking for a while to come.<\/p>\n When you are driving along and you see a speed trap \u2013 you slow down. However after you\u2019ve passed through it, you tend to continue to drive more slowly because you imagine that there is another right around the corner. Similarly, people tend to panic when their portfolio goes down with the market and they think there is more to come. On the flip side, investors tend to feel excited when their portfolio goes up and they tend to think it will continue to go up. But needless to say, these behaviors may prove to be damaging to the ultimate value of the portfolio.<\/p>\n What we need to remember is to focus on the long term goal.\u00a0 Markets go up and down every day! The current performance of the market does not alter one\u2019s goal to retire comfortably. And if one has prepared for the market volatility and can generate the income needed, regardless of which way the market is moving, then that comfortable retirement is just around the corner.<\/p>\nHave you ever driven through what you know was a speed trap?<\/h4>\n