Unveiling the Financial ‘Survival Instinct’ Inspired by ‘Shark Week’

During the well-known ‘Shark Week,’ Discovery Channel’s annual showcase of the ocean’s most formidable hunters, investors could gain valuable financial insights. Lessons from the iconic 1975 film, “Jaws,” featuring the terrifying great white shark, can shed light on a significant investor behavioural pattern.

Investors often fall into the trap of “recency bias,” driven by recent market events’ emotional highs and lows. This phenomenon, which frequently leads to monetary setbacks, causes investors to place undue importance on current happenings, such as a stock-market crash, the dramatic surge of bitcoin or a trending stock like GameStop.

Charlie Fitzgerald III, a certified financial planner based in Orlando, Florida, asserts that “recency bias is a normal, hard-wired survival instinct.” 

However, allowing temporary emotions to dictate long-term financial strategies is typically detrimental, as often evidenced by panic selling.

Recency bias can be compared to an irrational human reaction, such as avoiding the water after watching Spielberg’s “Jaws,” despite the extremely low probability of a shark attack.

“Imagine not wanting to swim in the ocean after watching ‘Jaws.’ The actual chance of a shark encounter is almost zero,” wrote Omar Aguilar, CEO and chief investment officer at Schwab Asset Management.

Fitzgerald likens this instinct to avoiding bees after being stung once or twice. He explained, “The recent experience can overpower all reason.”

Recency bias is often tied to FOMO, or “Fear of Missing Out.” Here’s a case in point:

In 2019, the financial services sector was one of the best performers in the S&P 500 Index, generating a 32% annual return. However, investors who pursued that growth and invested heavily in financial services stocks were likely dismayed when the sector’s returns dropped 2% in 2020. Meanwhile, the S&P 500 saw a positive return of 18%, as noted by Aguilar.

Financial advisors also pointed out other examples: overcompensating for disappointing international stock performance by focusing too much on U.S. stocks or relying heavily on a mutual fund’s recent implementation to influence investment decisions.

Aguilar warned that “short-term market fluctuations driven by recency bias can undermine long-term financial objectives, making it harder for clients to achieve their financial goals.”

Fitzgerald elaborated that the tendency usually originates from the fear of loss or FOMO, based on market fluctuations.

Attempting to act on these impulses by timing the market usually results in poor outcomes, such as buying high and selling low. Fitzgerald highlighted that investors are particularly susceptible to recency bias during significant life transitions like retirement when market instability can be unnerving.

For long-term investors with a well-diversified portfolio, weathering market storms without panic selling is a more viable approach.

According to Fitzgerald, a properly diversified portfolio typically includes a broad range of equity markets, such as large-, mid-, and small-cap stocks, foreign stocks, and potentially real estate. It should also contain short- and intermediate-term bonds and possibly a tiny cash portion.

Investors can achieve this extensive market coverage by investing in diverse low-cost index mutual funds or exchange-traded funds that track these sectors. Alternatively, they can invest in an all-in-one fund, like a target-date or balanced fund.

Asset allocation, or the distribution of stocks and bonds, should be guided by factors such as investment timeline, risk tolerance, and risk capacity, advises Fitzgerald. For instance, a young investor with 30 years until retirement would likely allocate between 80% to 90% to stocks.

Investors can harness the ‘survival instinct’ showcased during ‘Shark Week’ to guard against recency bias. By diversifying portfolios, focusing on long-term strategies, and avoiding knee-jerk reactions to short-term market fluctuations, they can better navigate the financial waters. Like the rarely-encountered great white shark, recency bias is a threat that, while daunting, can be managed with understanding, foresight, and a calm approach to investment decisions.