Neglect of prior base rates effect

This is the tendency to fail to incorporate prior known probabilities which are pertinent to the decision at hand.

Caution: Don’t read on if you are 40 years of age and above!

Here’s an interesting question for the rest of you:

Why aren’t more young people investing in the stock market?

Could it be that you/they are neglecting prior base rates and focusing too much on recent media hyped news about stock market corrections, which are actually insignificant in the long run?

And by that ignoring the long term upwards trajectory of almost all stock markets? (Japan appearing to be the odd one out here – could it be due to their challenging demographics?)

Have a look at these statistics:

  1. Whoever held shares for a minimum of 15 years in the US stock market would have never made losses (dividends re-invested), and this goes theoretically back to 1870.
  2. For holding periods above 10 years, the returns are minimum 8% per year (incl. dividends re-invested).
  3. Stocks fell almost 20% in late 2011, but do you still recall that?  Probably not.  Are you afraid of the current 10% correction (S&P 500) and thereafterthe next 20% crash?  Probably.  As of 24th August 2015 the S&P 500 is more than 60% higher than in 2011.  Think about that.

Yes, market returns are random and unforgiving in the short run and perhaps that’s why many older people would say that investing in the stock market is similar to gambling.

But that’s simply because they did not have enough time to allow the stock market to work its magic, since they either did not invest when they were young, or they frantically bought and sold only penny stocks, or even both.

The stock market is actually not suited for people who don’t have many years ahead of them.  Instead, it is meant for those with 30-50 years ahead of them, though that would always be the segment of the population with the least amount of money for investing.

Still, the prime investing years are in one’s teens and 20s, though the prime earning years are only in one’s 40s and 50s.

Time is clearly on your side; you only have to find a way to start investing when you have a little money and although it can be tough, it’s doable and the rewards are worth it.

Now, for those of you who paid no heed to the above caution (perhaps you temporarily forgot your age, well, it happened to me on several occasions):

1) If you are already strongly invested in the stock market for many years Congratulations!we all should learn from your example.

2) If you, however, have been sitting on the sidelines and merely watched the magic of compounding, do get off your comfortable sofa and participate in the stock market  because it’s easy (e.g., via ETFs).  Nevertheless, do yourself a favour and don’t expect to achieve those historic average returns within the next 5 years, since you might need to be a bit more patient  to achieve that.  Thus, take that into account and take charge of your emotions.

3) And if you have children, start a regular savings plan into a broad based ETF on their behalf (now), so that they can have the full advantage of the compounding effect (later).

tomorrow starts now; start an ETF savings plan

 

“Save money.  Avoid costly advice.  Diversify widely.” — Justin Wolfers

“Financial decision-making is not necessarily about money.  It’s also about intangible motives like avoiding regret or achieving pride.” — Daniel Kahnemann

“Some people spend more time planning a two-week vacation than they do retirement planning.” — Anonymous

“Perspective comes from having time and patience.” — Bhargava Rohit

2 Comments

  1. Hi Andy

    Great! A timely post to remind people about long term trend. I hope you have pick up a few good prices during the correction, thought it is just another up-and-down to us. haha.

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