Chasing Returns

A favorite (and costly) pastime of investors is to invest in assets that have recently done well. This happens in good times as investors seek better returns, and they happen in bad times as low-yielding investments such as cash are more attractive than money-losing stocks. In other words, investors chase returns.

By investing in what just did well, investors are systematically buying after they witness gains elsewhere and selling after their assets experience loss. Chasing returns can feel very good at the time but comes with a real financial cost. Dalbar, Inc. estimates that equity investors underperformed the S&P 500 by roughly 6% per year over the last 20 years1 due to the timing of buying and selling.

Why We Chase Returns

There are two primary reasons it feels right to buy after we witness gains and sell after experiencing losses:

  1. We are greatly influenced by what just happened. Whenever we try to project the future, our brains are significantly influenced by what just happened. Good outcomes today implies that things will be good going forward, and vice versa.
  • This is exacerbated by the narrative of the day. Our brains love a good story. We seek information to understand. When the market goes up, the narrative is often positive, leading us to feel good about the future. When the market goes down, the narrative is almost always negative, reinforcing a negative outlook.

Normal, But Not Beneficial

It is completely normal to invest in things we expect to go up and avoid assets we expect will go down. In fact, any rational person would do that as part of their investment strategy. But the problem is that markets move quickly and often surprisingly. Narratives are wonderful and can be quite accurate in hindsight. They can even increase our confidence in a certain viewpoint, but narratives offer no predictive ability in future outcomes.

This is why we advise you to remain disciplined to your plan and stay the course. We recognize this is not easy; temptations abound that are pleasing to our mind and feelings. But that is why you have us. Together, we can be aware of common investment pitfalls and ensure that all investment decisions are well-thought and in line with your stated objectives.

©2022 The Behavioral Finance Network

  1. JP Morgan Guide to the Markets. July 2022 edition. Slide 63.

If Money Doesn’t Buy Happiness, What Does?

For centuries mankind has been searching for happiness. Regardless of culture, social status, or beliefs it seems that we are all connected by our desire to be happy. What makes someone happy and how much happiness we feel may be subjective. But there are a few fundamental principles that tend to detract and add to an individual’s happiness.

In difficult or uncertain financial times, it can be helpful to take a step back and assess what makes us happy and what doesn’t. The good news is that everything that leads to lasting happiness is in our control.

 What Doesn’t Bring Happiness

Money, power, and prestige don’t bring happiness. Yes, they can provide certain opportunities that people may value, but they can also cause misery. The evidence is all around us. Money, power, and prestige can have insatiable appetites. Rather than feeling satisfied and content, we may feel urges to pursue more of it. This hedonic treadmill continues as we amass more, while never becoming satisfied.

The incessant pursuit of “more” often brings about negative feelings and behavior such as selfishness, backbiting, and egotism. Those are not the fruits of someone who is happy. But those are the qualities we see among many of the rich, famous, and powerful.

Three Drivers of Lasting Happiness

  1. Altruism/Selflessness. It is human nature to be selfish; us before them. Yet those that can rise above that instinct and sacrifice their own time, pleasure, and/or possessions for others find a huge return on investment. A return that is better than money.
  2. Positivity. There is so much negativity out there. In the daily news and even in comedy. Many seek laughs by putting other people down. It may provide a moment of thrill or happiness, but it is fleeting. We can find more enduring happiness by talking well about others and choosing to see the good in other people, even those we disagree with.
  3. Gratitude. People that demonstrate gratitude, especially for the little things, exude happiness. Gratitude helps us be less selfish, think highly of others, and keep our ego in check. Maybe we could say it’s the antithesis of unhappiness.

Our circumstances certainly play a role in how easy it is to feel happy, especially those moments when we experience a burst of intense happiness. But lasting happiness is more a function of how we think and act. While the world and markets may be uncertain and volatile, we can take comfort in knowing that much of our lasting happiness is within our control. 

©2022 The Behavioral Finance Network

Trusting Your Investment Decisions

Decision-Making Under Uncertainty

Investors face a very different environment today. While the future is always uncertain, today’s environment may be even more uncertain. We are living in a time of increasing inflation, increasing interest rates, and tighter fiscal and monetary policy. We aren’t used to this.

Making good decisions is always desirable. But when we face greater uncertainty, it is important that we trust whatever decision we make. A decision that looks to be “bad” in the short term can be quite profitable in the long run, and vice versa. So, how can we develop greater confidence in our decisions and trust them, even when they may not look so great in the short run?

Three Steps to Trusting Your Decisions

  1. Take Your Time. It is normal and natural to react to things based on emotions and intuition. The brain wants to solve things quickly, so we need to engage the reflective part of our brain by seeking additional information and not reacting hastily.
  2. Gather Information. We should spend a significant chunk of our time gathering information, including contradictory information. This helps us see things from various points of view rather than the loudest, or most repeated, viewpoints.
  3. Talk It Out. We would love to help you gather information, ask the right questions, and have a thoughtful discussion. Including an honest and objective 3rd party to help you think and talk through things is one of the best things we can do anytime we face an important choice.

We cannot control nor predict the markets, and that is OK. Because we can control how we think, analyze, and respond to the markets. We have found that how investors respond has a significant impact on their ultimate results. We are here to help you obtain the best results, despite challenging markets.

©2022 The Behavioral Finance Network

The Power of Remembering

Memorial Day is a time of remembering, reflecting, and honoring those who gave the ultimate sacrifice for the freedoms we enjoy today. The act of remembering often brings feelings of gratitude, love, and a desire to do good to others. It is positive and empowering.

While remembering can be very powerful with respect to certain holidays or important dates, such as anniversaries and birthdays, we don’t have to wait for a special day to unleash the power of remembering.

We can remember an individual, a circumstance, or any event in our life to get greater meaning and purpose from it. And, ironically enough, when we take time to remember and reflect on the past, we often develop better perspectives to tackle the future.

Remembering and Investing

As investors, we can also remember lessons we learned from the stock market and even through our own prior decisions. Every investor has made mistakes; the question is whether we remember those mistakes and have a plan to improve on it in the future.

For example, investors have a great ability to hold onto securities that have gone down in value. At least they can hold on to initial losses and/or for a certain period of time. But at some point, many investors get exhausted and impatient. They have a knack for selling near market bottoms. That is because it is darkest near the bottom and imagining any recovery may seem like nonsense. “This time is different” they say.

And perhaps one of the most important things to remember during a period of temporary losses, especially those that may be swift and severe, is how much you have made over the past five or ten years. Taking a longer view can help us put the current commotion in proper perspective.

And that is the power of remembering. Whether it is remembering where our freedoms came from, important people in our life, or how the markets work, remembering improves our perspective and, therefore, can improve our future decisions, in life or with respect to money.

©2022 The Behavioral Finance Network

Some Thoughts on Thinking

The ability to think clearly and draw correct conclusions is necessary in everyday life, especially when it comes to making important decisions. But thinking critically is not natural; it’s not the way our brains are hardwired. Instead, we are hardwired to follow the path of least resistance, which often results in hasty and suboptimal decisions. This is especially prevalent when uncertainty, anxiety, and emotions are high.

Assumptions: Necessary, But Unreliable

Because we seldom have full information, we must rely on assumptions to fill in the information gaps. These necessary, but often spurious assumptions can cause flaws in our thinking and judgement. If information seems plausible, especially if it is part of a good “story”, our brains will accept it as fact and move on.

As investors, we may assume that an “expert”, who has a lot of experience and is a frequent contributor on financial shows, knows what will happen and has our best interests at heart. We also unconsciously (and falsely) attribute one’s confidence with one’s ability to correctly predict the future. As much as we wish it were true, it’s not.

Even when we have full information, we still don’t know how others will respond – such as with the global shut down. Who would have thought the market would tread higher even as countries and economies shut down?

Critical Thinking is Critical for Investors

We are not born to be critical thinkers, just like we aren’t born to be great musicians. It takes effort, time, and practice. Critical thinking requires us to:

  1. Seek all available information – not just the information at your fingertips
  2. Play devil’s advocate – what if the opposite is true
  3. Challenge pre-existing opinions/conclusions

Cognitively, critical thinking is hard; it is draining. Which is why our thinking often defaults to the path of least resistance. And this is why you have us. We will do the heavy lifting. Thinking critically about the economy, markets, and your options are essential to making wise decisions. It may not be natural nor easy to think critically, but together we can ensure your financial decisions are thoughtful and in line with your plan.

©2022 The Behavioral Finance Network

The Holy Grail of Investing

Most investors would love to find the Holy Grail of investing – an investment that provides great returns with very little (or no) risk. Many investors consciously acknowledge that such an investment doesn’t exist. But we may still be attracted to that investment because of how badly we wish it would exist. And sometimes hope and desire, unconsciously, overrule logic and rationality.

A Recent Example

A few years ago, a mutual fund was created specifically for investors who were uncomfortable with volatility. The fund marketed itself as one that would “harness volatility” and “make volatility your asset.” It also claimed to be uncorrelated to traditional stocks and attempt to achieve both capital preservation and growth. Sounds like a real winner!

As you can imagine, money poured into this investment. It was marketed as the perfect investment for those concerned about volatility. It did well for a while, but just a single week of increased volatility blew the entire fund up. All the money was lost in less than one week! Ironically, volatility, the event the fund was going to “harness,” caused the fund to blow up.

Looking Forward

As investor concerns grow, we can expect that someone will create an investment product or strategy to “solve” the concern. Based on current headlines, we could see investments that claim to prosper during periods of inflation, stagflation, or “overextended” markets. No matter the concern of the day, we can reasonably assume the marketing will be very good – an emotional appeal to alleviate our concerns.

Our emotions and unconscious desires often inhibit skepticism and reasoning. Acting on emotions is the natural first response for many of us. It’s just the way we are hardwired. Thinking logically takes effort. That is why you have us. Together, we can ensure that your investment decisions are free from emotion, unconscious influences, and in line with your plan.

©2022 The Behavioral Finance Network. Used with permission.

Investing Amid Uncertainty

Investors express discomfort when things are uncertain. This is especially true when experiencing “heightened uncertainty,” such as with the current Eastern European conflict.

However, uncertainty is not just a circumstance of economic and investment markets, it is a fact of life. Our future, by definition, is uncertain. There are times when the future is less uncertain (the sun will rise tomorrow), but there are seldom, if ever, guarantees of future outcomes. In other words, life happens in probabilities. Learning to consider probabilities in our decision-making process will help us become more comfortable living with uncertainty.

The Probability Problem

The greatest challenge to thinking in probabilities is that it is just not natural. While gray matter fills our brains, they hate gray areas. They want to think in terms of certainty and will often convert a probabilistic scenario to either “will happen” or “will not happen.” An 85% chance of rain? The brain defaults to, “it’s certain to rain.”

When it comes to investing, we often hear terms such as “risk on” and “risk off” as if investing is just a switch. Investors similarly think in terms of “all in” or “all out.” This type of binary decision-making is natural, easy, and reinforced by the media. But it may lead to costly investment decisions.

Investing Probabilistically

Investing probabilistically is about adjusting your allocation, rather than making a significant move that amounts to a bet on which way the market will go. When the perception of the risk/reward balance is unfavorable, a small shift to safer assets is in order. And vice versa when the risk/reward balance is more favorable.

Because we cannot divine the future, the correctness of an investment decision should be based on strategy and probability, not the outcome. A good practice is to stop guessing what the market will do in the future. It cannot be known. Instead, consider making probabilistic adjustments proportionate with your risk tolerance. That will help you become more comfortable investing amid uncertainty.

©2022 The Behavioral Finance Network

The Challenge of Selling

Selling a security is something that investors ponder from time to time. Whether that security is an individual stock, a mutual fund, or an index fund, investors are left with the question of what to do with the proceeds.

No matter the reason for selling, it is important we have a well-thought plan for what we will do with the proceeds…before we pull the trigger.

Remaining in Cash

The default for selling securities is to remain in cash. Whether the markets are high or low, we may justify sitting in cash until the “uncertainty and tough times pass.” This logic relies on a significant (and incorrect) assumption – that there will be an all-clear signal that it is a good time to invest.

Sitting in cash may seem to be a comfortable and safe move, but it is fraught with uncertainties and long-term danger. When do we get back in? What if the market keeps moving higher? At what point do we realize that the train has left the station and we aren’t on board? 

Investing in Another Security

We may sell a security with plans to invest in a different one. Sometimes we are influenced to buy a security that has been performing better than what we own. The question we must ask ourselves is: “What evidence do I have that the new security will perform better than the existing one?”

This is an important question to reflect and discuss. A lot of money has been lost because investors sold and bought at the wrong time. This happens with both novice and professional investors, including institutional managers.

In a study spanning 24 years, researchers analyzed the trading results of institutional money managers. They found that the stocks they sold subsequently outperformed the stocks they bought at a cost of over $170 billion. The abstract summarized, “Plan sponsors could have saved hundreds of billions of dollars in assets had they simply stayed the course.”1

Thoughtful Selling

Of course, there are occasions when selling a security makes sense. But that should only be after purposeful thought and a plan of “what’s next” is created. It is so easy to sell, and our emotions can sometimes get the best of us. But that is why we are here. We’re here to help ensure your decisions are thoughtful and in line with your plan.

1. Scott Stewart, John Neumann, Christopher Knittel & Jeffrey Heisler, “Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors”, Financial Analysts Journal 65, no. 6 (2009)

©2022 The Behavioral Finance Network

A Dependable Forecast for 2022

Most investors love economic and market forecasts. With the markets so uncertain and volatile, our brain craves some sort of idea of what the future holds. But the markets are unpredictable – evidenced by the fact that no one can consistently predict them with accuracy. Of course, a certain forecast will be right from time to time, just like a broken clock. But market forecasts are not dependable, no matter what your brain tells you.

Unlike market and economic forecasts, our forecast is reliable and robust because it is based on enduring investment truths and investor behavior. These factors are more dependable than market outcomes and more important to an investor’s well-being.

Our 2022 Forecast

In full disclosure, the following forecast is nearly identical to our forecast for 2021 and years prior to that.

• The economy/market will do something that surprises us but will be obvious in hindsight

• Investors who watch the market often will experience more stress than those that don’t

• You will be tempted to change your investment strategy based on market performance, expert forecasts, and/or your personal beliefs about the future

• Your investment decisions and reactions to market events will have a significant influence on your personal investment return

• Investors that focus their time and attention on those things they can control will have a better investment experience than those that focus on what they wish they could control

Conviction, patience, and discipline are virtues every investor should develop. They aren’t easy, yet they are essential for your success. As your advisor, one of our most important roles is helping you ignore the noise and focus on what really matters to your financial success.

We wish you a prosperous, fulfilling, and happy 2022. Thank you for allowing us to be your trusted partner along the journey.

©2022 The Behavioral Finance Network. Used with permission.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.

Tis the Season of Forecasts

Every December we get inundated with forecasts for the following year. These forecasts range from expected GDP and interest rates to stock market performance.

We are naturally attracted to forecasts because they purport to tell us what is going to happen, and they often are supported by persuasive reasoning and statistical analysis. After listening to a confident and persuasive forecast, especially if it is one we hope will come to pass, we may be inclined to make changes to our investment strategies in line with that forecast. But herein lies the mental deception. While forecasts appear to reduce future uncertainty, that is only an illusion because the markets are simply unpredictable.

Over the past 20 years, when polling economists and market strategists as a group to come up with a consensus forecast, not once did they forecast the stock market would be down the following year. Yet, we experienced six negative years. But that is not all. Experts predicted several recessions that never occurred and have been predicting a bubble for the last several years.

When it comes to forecasting the market and economy, it’s not so much about someone’s experience or knowledge. It’s about the predictability of the event. The market is impossible to predict because the future, by definition, is uncertain. Unexpected events (life happens), our responses to world events, and randomness make accurately forecasting the markets an impossible task. The proof is in the fact that no one can do it – consistently.

Not all forecasts need be ignored. Some are better than others. Forecasts that offer a large range of potential outcomes can be helpful in setting our expectations for the future. Creating a vision of what is possible in the future is much more beneficial for our planning and decision-making than a specific forecast. Remember, the more specific the forecast, the more likely it will be wrong.

We read and review many forecasts that are published. We look forward to sharing with you in the coming weeks our thoughts along with productive expectations and perspectives to help us have a great 2022, no matter what the markets may do.

©2021 The Behavioral Finance Network