We all knew that Donald Trump would win the U.S. presidential election. In addition, we all saw the equity markets rallying following the expected Trump win. The recent bloodbath in the U.S. bond markets on the heels of the election was also no surprise.
Those of us who are honest with ourselves actually saw none of those events coming. However, as we get further and further away from them, and read more and more commentary rationalize them happening, we convince ourselves that each occurrence was not as great a surprise as when we experienced the events in real time. Behavioral finance advocates refer to this phenomenon as hindsight bias or the knew-it-all-along effect.
Most individuals are uncomfortable with uncertainty and seek explanations for events that are random or unpredictable. We all want to live in a world in which there is order. Hindsight bias encourages a view of a much more predictable world.
The real danger of hindsight bias is that we become more confident in our ability to predict future events as we rationalize the past. Confidence in most endeavors is a good thing. Overconfidence in our ability to predict future events can be very hazardous to our wealth.
I have a colleague who was concerned that Trump would actually defy the odds and win the election. He had his financial advisor make wholesale changes in his portfolio – selling completely out of equities and moving into cash. He believed a Trump victory would lead to a significant equity market correction. He was going to get out of the equity market and get back in once the market digested the election results. He was correct on his election call and completely wrong on the implications.
As we get further and further from the calamitous events of the financial crisis of 2007-8, more and more people claim to have seen it coming. In fact, only a select few individuals understood that the problems with mortgage backed securities (MBS) and collateralized debt obligations (CDOs). In reality, only a select few of those who claim to have seen the financial crisis coming could actually explain MBS and CDOs even today.
Too many investors feel the need to anticipate the future and make portfolio adjustments to take advantage of them. Most investors would be better off recognizing the random nature of events that influence the world’s financial markets. To paraphrase British politician John Major, investing is a very long game and the tortoise will usually beat the hare.