Broker Check

Why are so many investors still watching the party from the sideline?

| January 24, 2018
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The S&P 500 has gained 295% from the day the market bottomed out on March 9th, 2009 to December 31st, 20171 . In other words, it has nearly quadrupled in less than 8 years. This is one of the biggest and longest rallies the market has ever seen, yet as of December 31st, 2017 there is an estimated $15.5 Trillion sitting in cash accounts in the U.S1.  As a reference point, the S&P 500 has a market cap of only $24 Trillion. That would be like if only 60% of the school decided to go to the prom – and then Snoop Dogg showed up. So why have so many Americans been sitting this rally out? We are about to dive into the psychological side of investing. Sound the nerd alert.

The fact is, we get twice as upset about losses as we get excited about gains. If our brains are programmed to frame our decision-making based on the starting point, we will think and act differently depending on which side of that reference point we find ourselves. This is known as loss-aversion. So regardless of what the fundamentals say, if an investment is down, we are hesitant to sell because it means we “lost” money. If an investment is up, we are then tempted to sell and “lock in gains.” Objective analysis takes a back seat to our unconscious emotions. Emotional biases like this exist for everyone. All we can do is do our best to either limit their effects on our decision-making, or integrate them into the plan (i.e. accept that we are going to earn less and plan for it).

It is easy to see the impact this emotional bias can have on an individual portfolio. If we take a step back, we can see a significant impact on the investing community as a whole. The concept of myopic loss aversion is the idea that investors undervalue the benefit that the stock market provides over less-risky investments like bonds. Since 1928, equities have earned more than 6% per year in excess of bonds2Is the fear of loss really worth giving up 6% per year? Maybe. Probably not as much as most let it impact their portfolios. The bigger question is, does it really make sense to drop to 60/40 in retirement if you still need to fund 30 years of life expectancy?

So what about timing? You don’t want to get in at the wrong time, right? I did a quick Google search for data on the subject. When I typed in “buying in at the wrong time” all I got were articles about why you should try to avoid buying in at the wrong time, encouraging investors to time the market. So I had to run these numbers myself. Looking back 30 years, the S&P 500 Index has earned a geometric average return of 7.76%3. Had you invested a level dollar amount per year at the high point of each year (buying at the worst time), you would have earned 6.66%3. So even if you get it exactly wrong, but still have the discipline to invest consistently year-by-year, you’re only trailing the market by 1.1%. Which is a bigger mistake? Not buying in at exactly the right time, or missing 150% upside in the market?

One of the most important services we provide, that usually goes unspoken, is acting as a buffer between our clients’ emotions and their behavior. As Warren Buffett once said, “Investing is simple, but not easy.”

 

1 Source: JP Morgan Guide to the Market, Q1 2018 (slides 4 and 65)

2 Source: Federal Reserve database in St. Louis (FRED)
Equities represented by the S&P 500 Index.
Bonds represented by 10-year treasuries.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

3 Source: Yahoo! Finance (see table below)

 

G. Adam Weingartner is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker-dealer (member SIPC) and registered investment advisor. Bluestone Wealth Partners is a marketing name for business conducted through Lincoln Financial Advisors Corp. CRN-1998747-011818

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