Sam Sivarajan has led wealth management teams at several of Canada’s largest financial institutions and holds a doctorate in behavioural finance.He is the author of two bestselling books and can be found at www.samsivarajan.com.
Weekends are supposed to be relaxing. Health statistics suggest otherwise – traumatic injuries from crashes, falls and collisions are significantly more common on weekends than during the week. This weekend warrior syndrome is partly the result of health-conscious individuals trying to squeeze the recommended weekly exercise into Saturday and Sunday. But some fault may lie in the difference between what our heads remember (i.e., how fast we used to run or how much weight we lifted) and what our bodies can now do. In behavioural science terms, we have “anchored” on our past performance.
The anchoring bias refers to the human tendency to base our decisions on a particular reference point, or anchor. In the case of the weekend warrior, an anchor point can be a high school personal best. Research suggests that this anchoring bias can affect everything from salary negotiations to consumer purchases and judicial decisions. For example, one study asked subjects to think of the last two digits of their social security number. Then they were asked how much they would pay for a particular bottle of wine. People in the top quintile of social security numbers (i.e., with the last two digits of 80 to 99) were willing to pay three times what the people in the lowest quintile (i.e., with the last two digits of 00 to 19) were willing to pay.
In another study, a group of experienced trial lawyers were asked to make sentencing decisions in a hypothetical shoplifting case. After hearing the case, and before passing sentence, the subjects were asked to roll a (loaded) pair of dice. The subjects who rolled lower made significantly lower sentence recommendations than the subjects who rolled higher. Thus, irrelevant, and arbitrary, anchors were found to significantly influence key decisions.
Investors are not immune to this anchoring. A study of Scandinavian investors found that not only amateur, but also professional, investors anchored long-term return expectations on their historical estimates or an initial starting value. Such estimates also tended to be overly optimistic. This finding can have real implications for investors in the coming years. The S&P 500 returned -19 per cent in 2022 but 29 per cent, 16 per cent and 27 per cent respectively between 2019 and 2021. Investors anchored on those types of eye-watering, double-digit returns might be tempted to forget that the average annual return over the past 100 years (ignoring the many violent corrections) has been more in the 10-per-cent range.
Moreover, a 2016 report by the McKinsey Global Institute titled “Diminishing Returns: Why Investors May Need to Lower Their Expectations” pointed out that a series of exceptional economic and business conditions generated significantly higher returns over the past 30 years than the long-term trend. These conditions included dramatic decreases in inflation and interest rates; strong global GDP growth; and even stronger corporate profit growth. These conditions are unlikely to continue in the coming decades – we are already seeing the impact of higher inflation and interest rates, slowing global GDP growth and declining growth in corporate profits as input costs rise. McKinsey suggests that in this “golden” period, annual U.S. equity returns were 1.4 percentage points above the 100-year average and that, over the next 20 years, equity investors should expect a reversion to the mean in stock market returns.
This is not bad news for investors – after all, the long-term average equity return is still significant – just a reminder that past performance is no guarantee of future results. As Dorothy observed in The Wizard of Oz when she was suddenly transported to the strange new world of Oz, we are not in Kansas anymore. The same sentiment applies to weekend warriors who cannot relive their past results without serious risk of injury. Similarly, long-term investors should remember that market, economic and political conditions will be much different in the coming years than they have been over the past 30. That being said, over the long term, a well-diversified equity portfolio has always outperformed bond investments – there is no reason to expect this to change. As the legendary investor Sir John Templeton said: “The four most dangerous words in investing are, it’s different this time.”