The perils of historical delusion

Without considering context, rational decision-making is compromised

Because of its connection to rationality and achieving financial goals, historical delusion is a topic that fascinates me.

The philosopher George Santayana reminds us that “those

who cannot remember the past are condemned to repeat it.” But how many heed those words in practice? Too few investors, I fear.

Americans value history with little regard (as opposed to nostalgia, which is easy to sell). Regrettably, we are more likely to repeat past mistakes as a result, particularly when it comes to money. Memories are short and “wants” often trump “needs” for too many. Wise at it is, Santayana’s dictum does not promise that knowing and understanding history will prevent human or investing folly.

I am convinced that rational decision-making is compromised unless a strong foundation of historical context is included. Without considering the historical context, we risk being caught in a perpetual trap imagined by Karl Marx: “history repeats itself, first as tragedy, then as farce.”

History and context are important because without those perspectives, we might actually think that valuations in risk assets, fostered by generous central bankers, represent a reality that the economy has had a significant recovery. The political and economic environment is dominated by amnesia. With our short memories, the trauma of 2008 didn’t really happen or if it did, it really wasn’t that bad and is a further slip into delusion.

Short-term memories coupled with a “What have you done for me lately?” greed-based mantra will drive a number of investors to manage their resources themselves, or to abandon a perfectly sound financial relationship with a talented advisor or a competent fund or strategy.

The ‘why’ of investing

In no place is the context more evident than in comparing the annualized returns of the S&P 500, a common measure of the equity markets in the United States. The S&P’s annualized return, dividends included, for the past five years approximates 18 percent, but the 10-year average is about 7.4 percent. Care to guess on which statistic most investors focus?

Speaking of 2008 echoes, consider the surprising return of adjustable rate mortgages, subprime lending and payday loans. As a recent Wall Street Journal article noted, they are back in vogue. Of course, bankers and analysts say it’s different this time, and these “new and improved” products are unrelated to that nasty subprime binge that provided a catalyst for the 2008-2009 collapse. The legendary investor Sir John Templeton famously said that among the four most dangerous words in investing are “it’s different this time.”

Just five years ago the markets hit bottom in a climax of heart-wrenching volatility. I mention this because an old-time favorite investment tune has come back for an encore facilitated by the 24/7 media chorus: Why aren’t my investments up 30 percent or 40 percent? Behavioral investing expert Nick Murray correctly suggests, complementing Templeton’s words, that the five most dangerous words in investing are “everybody’s getting rich but me!” Greed takes over and the retail investor focuses on the “what” of investing rather than the “why.”

At moments of maximum stress, the behavior of investors matters far more than the investments themselves. During these moments of truth – when the current boom or crisis seems so unprecedented – thinking rationally and having a sense of historical perspective can be quite difficult. But understanding these biases is critical to our function as financial advisors.

I have learned much during my three decades of advising a wide range of clients, but this is one sobering paradox that no school can ever teach: Our advice is typically most valuable when it might be most difficult to justify from an emotional level.

Historical delusion flourishes when investors start chasing unrealistic returns, ignoring risk and goals and do so with limited patience. One imperfect defense to corrections in any market is to maintain balanced, broadly diversified and regularly rebalanced portfolios. This strategy will typically underperform during performance mania, but it is designed to deliver more consistent results that can be aligned with an investor’s long-term goals. By focusing on one’s goals (a fixed target), it is easier to maintain balance and perspective – again, it is the “why,” not the “what,” of investing that matters most.

Tom Sedoric, managing director-investments of the Sedoric Group of Wells Fargo Advisors in Portsmouth, can be reached at 603-430-8000 or through

Categories: Finance