If you have been watching the markets since the start of year, you might be feeling increased anxiety as you watch the numbers swing up and down every day. We certainly feel your pain. (We are in this together!) Many of you are no doubt familiar with the maxim, “Buy low, and sell high.” While that is the most logical way to invest, the truth is that our emotions tend to work against us when it comes to investing.
Take a look at the picture below. Based on the buy low and sell high wisdom, we should sell at the point that says “exuberance” and buy at “capitulation.” But rarely do individual investors really practice that advice. What typically happens instead, is that people invest around the point of optimism and excitement (when they start getting comfortable with the market’s trend), and sell at panic and capitulation. That’s right – if left to their own devices people will tend to do exactly the opposite of what they should!
That is why at Beacon Wealth we employ a long term investment strategy that is driven by factual data and timeless principles. We evaluate our portfolio performance every quarter and make tactical adjustments to our allocations based on leading economic indicators, current stock valuations and investor sentiment. (To see CEO Rick Laymon’s recent video on recent changes we made to our portfolio, click here.)
What is Recency Bias?
What would drive someone to make decisions that go directly against logic? One reason is something called “recency bias.” Simply put, it’s easier for us to use our recent experience to determine what will likely happen in the future. It works well in many areas, but not with investing. When the markets are only going up (eg. 2009-2014), we forget about all the times when they didn’t. Recent memory tells us that the market should keep going up. Likewise, when the market is down for any period of time, we become convinced that it will never recover so we move our funds to cash. We’re certain the market isn’t going to go back up because our recency bias tells us so. But then it does reverse course (usually sharply) and we find that we’ve missed the rally. The point is not that you should have been able to predict the movements of the market, rather that you need to be well-positioned when these market swings occur, as they inevitably will. In fact, of the 16 historical market corrections occurring without a recession (like what we are in now), the average cumulative rate of return in the following 5-year periods has been nearly 80%. In the 10-year periods following these corrections the markets have averaged a whopping 206% rebound!
Considering Marketing Timing?
This is the time when many so-called “experts” will try and convince us that market timing works. Of course, if one could successfully predict the highest and lowest days in the market, market timing would work. The problem is in the predicting. “CXO Advisory Group collected data from market forecasters from 1998-2012. The firm tracked and graded thousands of predictions made by dozens of popular market-timing gurus over the years. The overall results are not good. CXO has concluded that the market experts accurately predicted market direction only 48 percent of the time.”1 — about the same as a flip of the coin!
Hear what apostle James has to say about this issue of market timing: “Come now, you who say, ‘Today or tomorrow we will go into such a city and spend a year there to carry on our business and make money.’ Yet you do not know (the least thing) about what may happen tomorrow… You boast (falsely) in your presumption and your self-conceit.” (James 4:13-14, 16)
Making Good Decisions
The Harvard Business Review recently devoted an entire edition to the “Art of Decision Making.” One article titled, “Don’t Let Emotions Screw Up Your Decisions,” states that emotions can cloud our judgement and influence our decisions when triggered by the situation directly at hand. Research shows that emotions triggered by one event can spill over and affect another unrelated situation. How might this apply to you? If you have a bad day at work, or someone cuts you off in traffic and makes you angry, that can exacerbate your concerns about the market and cause you to make an unwise, rash decision like going to cash when the markets are down.
As financial advisors, we feel many of the same emotions that investors do when the markets are rocky. The difference is that we have some useful tools and our experience to keep things in proper perspective. In our recent 2016 State of the Markets webinar, we used some of these tools to talk about where we think we are in the market cycle and what we might expect in the future. If you haven’t watched it yet, click here.
· At the 22:15 mark we talk about the year over year change looking at all the leading indicators grouped together.
· At 27:25 we look at the normal number of “dips” and corrections each year.
· At 31:36 we compare the leading indicators from January 2008, July 2008, December 2008, February 2010, and today.
We think it’s helpful to look at these leading indicators over time. It should give you some comfort knowing that these indicators today look much different than they did 8 years ago.
We encourage you, as King Solomon did, to take the long view and employ a wise strategy with your investments: “Cast your bread upon the waters, for you will find it after many days. Divide your portion among seven, yes even eight, not knowing what misfortune may come upon the land” (Ecclesiastes 11:1-2). Lastly, this would be a great time to sit down with your wealth advisor to review your financial plan progress, reassess your risk tolerance and talk through any lingering concerns you might have. Give us a call to schedule your appointment.