Scenario A: You and a friend are flipping a coin and betting on the outcome. You have gotten heads the last nine times and keep betting on tails and are sure this flip it has to be tails!
Scenario B: Same situation but you have gotten heads the last four times and so figure you will bet on heads because it is hot right now!
Do these scenarios feel familiar at all? Which one to you identify with?
Logic tells us that every time a coin is flipped it has an equal chance of being heads or tails. Still, it is hard not to start making up patterns and predicting heads/tails based on the previous flips.
There are two points here that I am trying to make.
(1) It takes A LOT of flips of a coin to get to a point where half of them have been heads and half have been tails. We frequently jump to statistical conclusions without having enough sample points.
(2) It is in our instinctual nature to try to predict the future based on the past even though logic tells us they may not be related.
EVERY investor wants to predict future performance based on past performance. If performance is down for a few years it doesn’t necessarily mean it will be high next year. If performance is up for a few years it doesn’t necessarily mean it will be low next year. It might but … base those predictions/decisions on solid information and not just the assumption that there is a given performance pattern.
EVERY investor wants to jump to statistical performance conclusions. People are naturally short-term thinkers. They want to diet for a week and fit into clothes 2 sizes smaller. Keep in mind your timeline – are you investing for the next 6 months, or 3 years, or 20 years? Long-term investors need to stay away from responding to short-term performance trends.
By Cammie Humke, Registered Representative at The Humke Group, Inc
Located at 555 S. Randall Rd in St. Charles, IL, phone 630-377-7133
The Humke Group, Inc is an independent firm with securities offered through Summit Brokerage Services, Inc. Member of FINRA/SIPC. Opinions expressed are that of the author and are not endorsed by the named broker/dealer.