At one point, solar eclipses were viewed as something supernatural. Natural disasters, famines, and wars were often blamed on solar eclipses. An eclipse of the sun in 1133 was retroactively named “King Henry’s Eclipse” when the English monarch died two years later. Over time, such coincidences formed the basis of superstitions, and eclipses became a source of fear.
However, superstitions can be emotionally beneficial, allowing us to cope with anxiety and assign order to outcomes that otherwise don’t make much sense. When our pattern-recognizing brains look at financial market data, we naturally search for trends to help bring order to the chaos. Rules of thumb like “sell in May and go away” are a type of modern-day superstition, giving us a sense of control of the future that can amplify our biases.
While we have more certainty in the short term than the long term in our everyday life, it’s the opposite with financial markets. For example, over the last 25 years, on a day-by-day basis the likelihood of the stock market increasing or decreasing in value is about the same. But if we extend the time horizon to a year-by-year basis, the likelihood of the stock market increasing in value goes up to 82%. Thus, it makes sense to avoid decision-making over short-term periods, where randomness dominates outcomes, and to act more decisively over time horizons where financial market returns more closely resemble the slow but steady march of progress.
Another strategy for dealing with uncertainty is to align the investment portfolio with future goals. Assets earmarked for short-term goals should be invested conservatively, providing liquidity regardless of short-term market movements. Meanwhile, assets assigned to meet long-term objectives should be invested for growth to take advantage of a longer time horizon.
A goals-based approach marries assets (e.g. income, investments, and insurance) with liabilities (future spending goals), increasing the probability of meeting investment objectives. Shifting the focus from short-term market returns to investment success, defined as the probability of meeting personal goals, can also protect investors against a swathe of behavioral biases.
Our understanding of solar eclipses has helped to satisfy our pattern-recognition urges, so we no longer look for other ways to explain the phenomena. Unlike the hard science of astronomy, we can’t hope to fully understand or predict the “madness of crowds” that drives short-term returns. But by understanding what role our investments play in meeting our goals, reducing the role of chance in our financial success, and extending our investment horizon, we can put some certainty back into our lives.