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The biggest risks to our retirement financial security are almost certainly not the ones we’re most worried about.
I’m reminded of this paradoxical situation by deliberations at the current World Economic Forum in Davos Switzerland. This annual conference, held around this time, brings together government and business leaders from across the world. A key focus of their deliberations is a “Global Risks Perception Survey” (GRPS), which represents what the world’s global elite think we should be most worried about.
It’s not that the risks identified by the GRPS aren’t worrisome. But, by definition, those risks are ones that we already know about, and presumably are already discounted by the market. It’s the risks that are not on our radar screens that could really sabotage our financial security.
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These insights are hardly new. They underlie concerns about so-called Black Swans, which are sudden, awful, unpredictable and rare. But the World Economic Forum provides the perfect occasion to focus on these concerns because this global gathering illustrates how even the world’s most powerful and richest fall prey to focusing on yesterday’s news.
Take what the GRPS in early 2009 identified as the top global risk, in terms of both likelihood and impact. That survey was conducted just as the 2007-2009 Financial Crisis was coming to an end, after asset prices had already collapsed. In true “closing the barn door after the horse has bolted” fashion, the top risk in that year’s survey was “Asset Price Collapse.”
This is an example of a widespread cognitive bias known as “recency bias,” in which we give greater importance to that which has happened recently. I think you can agree that both equities and fixed income are hugely more overvalued today than they were in early 2009. So the risk of an “asset price collapse” is objectively higher today than then. Yet in this year’s GRPS survey this risk does not even make it into the top 10 biggest risks.
A similar illustration of recency bias is where “infectious diseases” falls in the GRPS risk ranking. Two years ago, before the COVID-19 pandemic, this risk was in 10th place in a ranking of “the top 10 risks in terms of impact.” In contrast, in the 2021 GRPS, one year ago, conducted as the pandemic was in full swing, “infectious diseases” jumped to first place. This year, as many envision COVID-19 becoming merely endemic, the risk has dropped to sixth place. Yet it’s not at all clear that, in any objective sense, the risk of infectious diseases has changed much from where it stood one year or two years ago.
The investment implication of this analysis is that we need a financial plan that specifies how we will respond to unexpected developments in the markets. Black Swans by definition are unpredictable, and the markets respond immediately when one occurs. So your financial plan must be laid out in advance, since it will be too late to react after the unexpected has occurred.
Otherwise, we will constantly be in a reactive mode, with our portfolios periodically selling assets after they have fallen and buying others after they have risen. That’s another way of saying we will constantly be buying high and selling low—a surefire recipe for losing.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.
