Imagining the future of your savings in ten years, suppose you are offered a choice between two options. In the first, you will lose purchasing power with certainty, with a decrease of between 2% and 22%. In more than half of the cases, the loss will exceed 10%. In the second option, the probability that your purchasing power will decrease is only 4%. With this option, in addition to gaining purchasing power in 96% of the cases, the maximum loss is only 15%. As for the increase in your purchasing power, exclusive of this option, the real gains exceed 35% with a probability of 80%, and in thirty out of a hundred cases, your money doubles its purchasing power. Which do you choose?
These two options are based on data from the 152 120-month (10-year) periods between January 2002 and July 2024. The data for the first option are the average return of money market funds accumulated over ten-year periods, minus the Spanish inflation rate for those periods.
According to inferential statistics, a branch that deals with making predictions based on a representative sample of data, we can affirm that those who remain invested in money market funds (or deposits) for ten years will lose purchasing power. By having access to all the fund data, through Morningstar Direct, and the Spanish CPI (INE), we can infer probabilities with a very high level of confidence. In this case, furthermore, the hypothesis that investing in money market funds results in a loss of purchasing power after ten years is an event with very little variability, since it has always occurred in this century. And that is before taxes, the effect of which has not been subtracted in the calculation of probabilities of a decrease in purchasing power.
In the second option, the data correspond to the accumulated real profitability over ten years of the average of the funds in the Flexible Cap Global Equity category, that is, they can invest in companies from all over the world, whether large or small. I have chosen this category because, in my opinion, it is the one that offers the greatest diversification. Although large American companies have been the clear winners since 2008, this was not the case in the previous period. Therefore, thinking of savers whose objective is to preserve their purchasing power in ten years, I think it is essential to diversify between countries, sectors, styles and company sizes. But in all equity fund categories, whose references are broad indices not limited to a country, sector or style, the probability of real loss after ten years is less than 5%.
When it comes to investing, our minds often play tricks on us. Humans are not naturally good at assessing probabilities, and this is largely due to cognitive biases that affect us all. These biases can distort our perception of risk and lead us to make inefficient decisions.
One of the most common biases is the availability bias. We assign probabilities based on data that is readily available to us. After a year in which the stock market has performed poorly, it is easy to fall into the trap of overestimating the likelihood of another down year. This bias occurs because recent or emotionally impactful events, such as 2022, are fresh in our memory and therefore seem more likely than they actually are. However, historical data shows that losing years in the markets are relatively rare and two consecutive losing years is extremely unlikely, and yet most investors struggle to invest after a bad year in the markets.
Furthermore, people tend to seek out and favor information that confirms their preexisting beliefs, which is known as confirmation bias. If an investor believes that the stock market is expensive, they are likely to focus only on news or analysis that supports this view, ignoring any evidence that valuations can be sustainable over time. Additionally, we tend to assign probabilities based on our personal experience, which can be extremely limited and not representative of reality.
Emotions also play a crucial role in how we perceive risk. Events that provoke a strong emotional reaction, such as large market declines, are often overestimated in terms of future probability. Meanwhile, more subtle, but equally dangerous, risks, such as inflation, tend to be underestimated or even ignored. This imbalance can lead us to overestimate the safety of investments such as money market funds, even though the data clearly indicates that, over the long term, these investments are very likely to result in a loss of purchasing power.
Overcoming these cognitive and emotional biases is key to making more efficient investment decisions. By recognizing these thoughts, investors can adopt a more rational approach based on data and probabilities, rather than being swayed by distorted perceptions or fear of improbable risks. To help you, I suggest you seek help from a professional advisor.
Marta Diaz-Bass She is the managing partner of strategy at atl Capital.
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