You’ve got to know when to hold ‘em
Know when to fold ‘em,
Know when to walk away,
And know when to run.
CCR Wealth Management’s Outlook communication seeks to update our clients on market conditions currently affecting or which may affect asset values and investment performance. Our commentary often responds to a prevailing market “narrative” that is bandied-about in the news and various media channels and is therefore often on the minds of our clients. As our regular readers know, we stay generally light on market “data”, blow-by-blow recaps of recent quarterly index interest rate or currency movements-except where it has become part of the “narrative”. Today these items are all easily obtained with a few clicks on the internet. They usually have limited utility in forming or in-forming a relevant longer-term investment strategy.
We do, however, try to provide our clients with “food for thought” in our commentary about market conditions or investment narratives which intersect with recent or expected returns, volatility, or other newsworthy investment topics. For two years we have been recommending our clients adjust their expectations to choppy markets and lower average returns. We have also discussed the various ingredients at play which produces such results. In doing so, on occasion we have also made reference to Behavioral Finance topics which best encompass or describe some of the cognitive or emotional tendencies investors exhibit when investing in more volatile markets. In the last year we have touched on “Recency Bias”, and the “Gambler’s Fallacy”, for example.
Behavioral Finance is a broad field, but much of it is concerned with recognizing cognitive and emotional biases which prevent investors from making optimal investment decisions. The study of Behavioral Finance provides a framework to recognize the commonality of such tendencies across all investors and hopefully, with such awareness, to improve our investment approaches. We hasten to point out that investment professionals (from pension managers to analysts to traders and financial advisors) are also subject to behavioral biases which may cloud decision-making, and which requires awareness. Behavioral biases are, simply put, a by-product of human nature.
We daresay the quote atop this page will be familiar to the majority of our clients as the lyrics of the “The Gambler”, a song made famous by Kenny Rodgers in 1978. In volatile markets, it is not unusual to witness “long-term investors” suddenly view the capital markets as a casino, with the odds stacked against them to boot. We have often thought of these lyrics when reflecting on the actions of some clients (both past and present) and the propensity of many investors to subconsciously substitute their long-term investment strategy for retirement with a highly emotional, headline-driven, “lightly informed” strategy akin to taking their chips off the table at a gambling casino. Decisions based on “hunches”, “gut feelings”, or last night’s ‘Mad Money’ with Jim Cramer episode subvert more rational evaluations. Unfortunately, many investors consider “walking away” or even “running” viable components of a long-term investment strategy. They are not. They never have been. All evidence backs this up.
The Dalbar Quantitative Analysis of Investor Behavior is an annual in-depth study of individual investor behavioral patterns, gathered through examining vast amounts of mutual fund trading data. The 2015 edition is the 22nd iteration of the analysis. According to the study, the rolling track-record of investors is consistent and telling. Over 20 years, investors don’t even keep pace with inflation. Among the report’s findings; Psychological factors (behavioral biases) were the number 1 reason, accounting for over 50% of investors’ shortfall versus a relevant benchmark. In a nutshell, it is human nature to sell low and buy high. High commissions and fees was the number two reason, at about a 25% attribution, followed by a lack of capital (to remain fully invested). In other words: Presidential politics, geopolitical uncertainty, and market volatility cause investors to repeatedly head for the exits.
We recently attended a Wealth Management summit in New York. A quote from one of the presenters, Andrew Goldberg of JP Morgan is particularly appropriate:
“Your portfolio is like a bar of soap.
The more you touch it, the smaller it gets!”
Volatility is the norm in equity markets—not the exception. Regular readers will recognize the following chart, which has been updated to reflect 35 ½ years of market returns and mid-year corrections through June 30th of this year:
When you think about it, 35 years arguably encompasses the majority of an individual’s investment horizon. Considering the chart above, if you have a tendency to “sell” at the red dots, it becomes fairly clear how you end up with the average investor’s 20-year performance of 2.1%, as Dalbar’s research shows.