A Valentine’s Day Gift
December’s market selloff- or rather, January’s recovery, provided investors with a tremendous gift. We now have the rare opportunity to reassess our portfolio and perhaps more importantly, our behavior and tolerance for risk, without the usual triggers for such evaluation; namely significant loss of capital.
As many studies have shown, the vast majority of investors experience the pain of losing money more strongly and ascribe to it a greater sense of loss than the joy of increasing their wealth by similar amounts. Investors also have a strong tendency to overstate their risk tolerance during times of low volatility such as those experienced since the market recovery began in 2009. We also know from other studies conducted by Dalbar, Vanguard and others that individual investors are historically poor market timers and under-perform their relative benchmarks by hundreds of basis points (1 basis point is 1/100th of 1%) on an annualized basis over long periods of time. Accordingly, there’s a strong correlation (dare I say…cause?) between market losses and increased volatility, and when most retail investors evaluate their their allocations or worse, their entire investment strategy. When volatility increases and investors begin experiencing discomfort associated with losing money, they try to correct by adjusting their portfolios to what is likely, a more appropriate long-term (strategic) risk allocation. Unfortunately this is often done at exactly the wrong time.
So if you managed to remain calm and didn’t take action between early December and today, congratulations! You’ve avoided a classic investing mistake and your portfolios are better off in the short and long run if you’re able to remain disciplined through market corrections. Now that daily market swings have been sub-1%, it’s time to evaluate how you felt about the market turbulence and your portfolio fluctuation. If you were uncomfortable watching the news, looked at your 401k balance or called your advisor asking when the “pain would stop,” (caution: if your advisor gave you an answer with any confidence attached to it, it’s time to call me) now is the time to adjust your portfolios to better align with your measured risk tolerance. If it’s been awhile since you’ve quantified your appropriate risk tolerance, ask your advisor- or us- for help! Take time to determine whether your long term allocations are appropriate and whether you can really stomach an extended market downturn. Ask yourself if you are a trader, market-timer or investor. For the most part, the primary difference is merely time horizon. It helps to remember that on any given day, it’s roughly a coin toss as to whether the markets or up or down. But as you zoom out on your investment time horizon, the likelihood of profits gets higher and higher. Pretty soon, you won’t be a market-timer or so anxious about your portfolios – you’ll be an investor seeking positive long term risk-adjusted returns to help you reach your goals. And that’s the best gift you can ask for from Mr. Market.
Happy Valentine’s Day