TGBA # 32: Past is Prologue: Learning from Fukushima and the Vltava River

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Based on an article published in the Globe & Mail on Feb 14, 2024

The Fukushima Daiichi nuclear disaster in 2011 was a catastrophic event that highlighted the dangers of ignoring history and building in flood-prone areas. The operator of the Fukushima Daiichi nuclear power plant, Tokyo Electric Power (Tepco), dismissed warnings that the complex was at risk from a tsunami and rejected the need for better protection against seawater flooding. The plant, located on a 3.5-square-kilometre site in the towns of ōkuma and Futaba in Fukushima Prefecture, Japan, was hit by a tsunami more than 14 meters high, which led to the meltdown of three reactors.

The warnings Tepco ignored were not just recent. In fact, they were etched in stone centuries ago. In the foothills surrounding Aneyoshi, a coastal village in Japan, 19th-century survivors of large tsunamis had engraved warnings into the rocks. One such inscription declared, "High dwellings are the peace and harmony of our descendants. Remember the calamity of the great tsunamis. Do not build any homes below this point". Despite these clear warnings, Tepco and other recent residents of coastal Japan built homes and eventually nuclear facilities in these risky locations, leading to the Fukushima disaster.

Yet, the story of Fukushima is not just one of disaster, but also of resilience and lessons learned. The Onagawa nuclear power plant, located even closer to the earthquake's epicenter, withstood the same earthquake and tsunami. Its survival was not due to luck, but to careful planning and preparation. The plant was built at a higher elevation, and its operators had undergone extensive emergency training, including for a massive tsunami. They were ready to shut it down when disaster struck.

The tale of these two nuclear plants serves as a stark reminder of the importance of acknowledging and preparing for risks, rather than ignoring them. It underscores the need for robust safety systems, thorough testing, and continuous learning from past mistakes.

The Fukushima disaster is not an isolated case of societies ignoring historical warnings about natural disasters. A study on the Vlatva River in the Czech Republic showed a similar pattern. The study found that extreme floods occur approximately once every 100-200 years. Immediately after such a flood, and for two generations afterwards, people move back from the riverbanks and build further away. However, by the time of the fourth generation after the last flood, memories have faded and people come back closer to the riverbanks, only to invite disaster.

Here’s the sobering reality. It is not like we weren’t warned. The villagers in Aneyoshi spoke from beyond the grave to warn future generations. Similarly, current generations are reminded of the historical floods in Prague—the maximum heights of many of which are marked along the Vltava’s banks. Whether it is forgetfulness or hubris, this reliance on a small sample of recent events has serious risks and consequences.

Escaping the Recency Bias Trap

Many of our clients fall victim to "recency bias" - placing too much emphasis on recent events and extrapolating them too far into the future. As behavioral economists Denrell and March explain, individuals act as if they underweight the probability of rare events due to reliance on small samples and recency effect. They use the analogy of a cat stepping on a hot stove. Based on this small sample, the cat won’t come anywhere near a stove in the future - hot or cold.?

This reliance on small samples can be seen everyday. For example, the high inflation environment in 2021-2022 took many by surprise because they underweighted the experience from the 1970s and 1980s and overweighted the low inflation years since 2000.?

Similarly, current geopolitical risks were underestimated due to the long period of relative geopolitical stability over the past 30 years.

This recency bias causes clients to make suboptimal investment decisions, such as:

• Panic selling stocks during short-term market declines, locking in losses
• Avoiding international investments due to near term headwinds
• Overallocating to asset classes that have recently outperformed

Imagine sitting across from your clients, relating the cautionary tales of Fukushima and the Vltava River. These are real-world examples that underscore the cost of ignoring history's lessons.

But why should we care? Because, like Tepco and the residents along the Vltava River, our clients risk making suboptimal investment decisions. They may panic-sell during market dips, avoid international investments, or overallocate to trendy but risky assets.

As advisors, we need to help clients see the bigger picture and not become blinded by short-term events. Here are 3 techniques you can use:

1. Reference long-term data - Show clients charts of market returns, inflation, and other indicators over multi-decade periods to highlight previous cycles and mean reversion. This helps counteract the natural tendency to focus only on the most recent years.
2. Use historical analogies - When faced with current risks like inflation or geopolitical events, draw parallels with similar historical periods, which can provide useful insight without overextrapolating the present.
3. Conduct scenario analysis - Evaluate portfolio impacts under a range of potential scenarios to understand the spectrum of outcomes. Remember there is no certainties, only probabilities. Teach your clients to assign probabilities to different possible outcomes. This avoids anchoring only on the recent past.

Implementing these behavioral "nudges" can lead to better investment decisions. Wise advisors can help clients break free from the recency bias trap.

After all, as Mark Twain noted, “History doesn't repeat itself, but it often rhymes.”

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