What is regression to mean
Regression to the mean
The "regression to the mean" (RzM) (actually a term from the theory of statistics) has a high relevance for you as an investor: It describes the tendency to swing back to the long-term average return of asset classes, stocks and funds after particularly high or low returns Returns have occurred.
Important: “Regression to the mean value is only the expression of certain causes, but not the cause itself. […] RzM does not mean, of course, that every above-average annual profit is followed by a lower profit. […] Excess or under-returns are in most cases of a temporary nature. […] In other words, the markets caught up again after falling sharply. [...] This is an indicator for the well-known insight that the expected return after a crash increases significantly. "(Kommer, 2018)
If you know the regression to the mean, this will help you twice for your long-term return:
1️⃣ You make better investment decisions because you are not chasing pointless short-term outperformance (“performance chasing”).
2️⃣ You can sleep more peacefully because you understand temporary downturns and (book) losses better as such and can accept them more calmly and thus avoid emotional and impulsive decisions.
What is your opinion on the regression to the mean? Have you ever deliberately acted countercyclically because of the regression to the mean?
Originally published on my Instagram account @FinanzTilo
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