Rising Geopolitical Risks and Overcoming the “Focusing Illusion”
The escalating geopolitical tensions significantly influences our perceptions, often leading us to draw connections between complex global events and anticipated financial market shifts. In the process, we tend to lose sight of our long-term objectives, treating current events as pivotal moments without fully acknowledging their historical insignificance on a well-diversified long-term investment portfolio.
While these events do matter from a perspective of human loss and suffering, their financial impact on long-term investment portfolios tends to be minimal. Conflicts like the war in Gaza may have devastating implications for the region’s populace, yet they often lack material repercussions on a broader financial scale. These events do matter but we cannot predict with any degree of confidence how it will impact investors outside of these specifically affected areas.
There are always high-profile risks that draw our attention. We typically have no control over these external events, other than how we will respond to them. Humans have a negative bias when confronted with uncertainty and we tend to zoom in on these risks ultimately compromising our investment composure and long-term perspective.
What should we do?
We need to zoom out and consider how much it matters purely from a financial perspective. Historically it has proven to be less influential on our long-term objectives than anticipated.
Consider the following critical questions:
- Can we confidently predict the outcomes of our concerns?
- Can we foresee the consequences and financial market responses?
Historically we don’t manage to get the answers to these questions right with any consistency. Moreover, attempting to time our portfolio decisions amidst market fluctuations seldom yields profitable outcomes. As Peter Lynch aptly stated, more losses stem from attempting to predict and prepare for corrections than from the corrections themselves. It is critical to ask the right questions.
Better questions would be:
- Are any of these financial market implications likely to be material over my investing horizon?
- Has there been any change to my investing objectives?
For long-term investors it is usually only necessary to reconsider their current portfolio exposure due to life transitions or changing conditions in their personal lives.
The Focusing Illusion
Things happening in our lives right now always feel very important. The more we think about it the more important it feels. The simple idea that by focusing on something, we elevate its importance is called “The Focusing Illusion”.
People have a tendency to focus on one aspect of their lives while ignoring other aspects. We tend to magnify the importance of present circumstances. For example, when prompted to think about their income before rating their well-being, people automatically overweigh the importance of income for well-being. Thinking that more money can make you happier, and thus making having more money essential. Our focus becomes so narrow that we overlook relevant information.
When attention is fixated on immediate concerns, we may neglect to consider the long-term consequences of our decisions. Whether it’s sacrificing work-life balance for short-term productivity gains or ignoring environmental impact for immediate profit, tunnel vision can blind us to the broader implications of our choices.
When we focus on a single event over which we have no control we end up losing the broader perspective and tend to undermine our own well thought out long-term strategies. How many of the things that you worried about in the past turned out to be as big or important as you feared?
Lessons from the Great Financial Crises
Reflecting on past experiences, such as the Great Financial Crisis, provides valuable insights.
The Great Financial Crises started in October 2007. An investment in the market from that starting point would have suffered a total drawdown of – 55,3% by March 2009. “This time is different” felt very real. Ideas like “the new normal” were birthed and conventional wisdom was challenged.
Within the following 10 years, from October 2007 to September 2017, the market not only recovered the full drawdown but also doubled the initial investment with a +100% return. The return from the March 2009 low over the next 15 years to March 2024, was +916%. Despite the turmoil and uncertainty, history reveals the resilience of markets over the long-term.
Most investors did not benefit from this recovery as they altered their asset allocation and risk exposure in response to what was happening in the moment. We tend to sell into market declines waiting for a recovery. Rationally we know this is not a profitable strategy but we find it emotionally difficult to keep perspective and remain disciplined. Markets change over time, but human behaviour does not.
Market corrections have a way of distorting time horizons, causing investors to lose sight of the bigger picture. The focusing illusion causes us to elevate the perceived importance of our immediate challenges and diverts our attention away from our long-term goals. Temptations to react impulsively can derail investment strategies, leading to irreversible consequences.
Joe Wiggans sums it up perfectly when he says: “We lurch from one potential major risk to the next, almost always overstating its importance and each time making some ill-judged predictions. Investors need to worry less about geopolitical events, and more about the poor decisions we will make because they are the focus of our attention”.
The biggest risk to meeting personal financial long-term objectives is the investors own behaviour. Our choices have consequences.
The above article was written and adapted by Marius Kilian.
Source
*“Nothing in life is as important as you think it is while you are thinking about it”, I. Maserov, medium.com, April 2024
*” An Investor Checklist for Dealing with Geopolitical Risk”, Joe Wiggans, behaviouralinvestment.com. 23 Apr 2024
*“The Advantage of Low Stock Market Expectations”, Danny Noonan, morningstar.com, 23 Apr 2024