After an event has taken place, people have a tendency to feel that he or she could have predicted the outcome or report having a feeling that it would turn out that way. Also known as the ‘knew-it-all-the-time effect’ or ’20-20 hindsight’, it can cause memory distortion leading to overconfidence in predictions.
When investors believe that they could have or should have predicted market corrections after they happen, it can lead to significant disappointment and guilt. Sometimes this distorted view results in an investor making changes to his or her portfolio strategy by selling securities, altering the amount allocated to bonds or stocks or suddenly cutting risk tolerance and shortening investment time horizon. Major strategy changes after the market drops can have a catastrophic impact on long-term investment success.
The best time to alter your investment strategy is when investment markets are robust and calm, not after they have dropped in value during a correction, or when they are volatile. If you recognize that you are susceptible to this bias, set rules governing when to update your investment strategy, as part of your Investment Policy Statement (IPS). In your written plan, consider including guidelines outlining when you are permitted to change your time horizon, how often you will re-balance the amount of money allocated to stocks or bonds, and what your tolerance to volatility is.