The talking heads and supposed experts have done a good job of scaring investors away from the markets. Their job isn’t to help investors reach their financial goals, rather they are looking to shock investors and make them stay tuned to the channel to learn more (and of course watch their advertisements).
“A connoisseur of woe, needs fresh worries from time to time, or he will become complacent”
Peter Mayle, A Year in Provence
A recent post at dragonflycap.com, has done a pretty good job at classifying these fear mongering talking heads. Greg Harmon, breaks them into three categories:
The Postponement: Their rhetoric sounds like this, “The big market decline we’ve been talking about is going to happen, just not as soon as I said”. This camp believes something big is coming and that it’s always right around the corner. Remember Y2K, the election, the fiscal cliff, and even the recent Fed announcement?
The Rationalization: After a pundit makes a prediction and it turns out to be wrong, his strategy may be to rationalize why some unforeseeable event prevented his prediction from coming true. It’s easy to explain everything away after it’s already happened.
The Decay: These “experts” look for all the small disappoints and set backs and attribute it to an overall decay of the markets, the economy, the country, etc. This camp will look into the lowering of the GDP and turn it into something much, much larger.
These mindsets can be debilitating to an investor if they only look for the negative stories. It’s important to remember these are opinions of people paid to keep you watching the TV and reading their articles.
It’s been a big week! But don’t lose focus on the long term.
Too many people are making a big deal over the Fed’s announcement earlier this week, resulting in traders kicking up a lot of dust in the markets and the talking heads dissecting the meaning of the announcement. Let’s keep a few things in perspective:
1) Nothing substantially new was stated except that the Fed’s bond buying may begin to taper off at the end of this year as opposed to early next year.
2) This was not unexpected news. This was already hinted at a few weeks prior. We already knew this.
3) The life support, QE3, or Fed’s efforts to help the economy must end someday. Did everyone forget that it was bound to happen?
4) Bernanke even stated that any policy changes would be contingent upon the economy’s CONTINUED growth. As the economy strengthens and can stand on its own, the Fed would reduce aid accordingly. And at that time, shouldn’t it be celebrated rather than shunned?
There is some volatility in the markets as a result this announcement. It may continue for a while. Is it a little speed bump or is it the sign of something more? We will wait for the dust to settle to see where things stand. We may see opportunities as the market rebounds.
We’ve fielded a few phone calls from clients in the past few weeks confused about why their statements are not reflecting the same rate of return of the S&P 500 which they’re hearing about in the news.
We’re not surprised by the observation.
The S&P 500 has been having a banner year so far! US equities have been our best performing asset class. Actually, it’s one of the few asset classes that has maintained a positive trend over the last few months. While almost all other asset classes have been struggling to show any gains, such as commodities, bonds, real estate, and some foreign holdings, the US equity market has been surging ahead.
It’s as if the US equities were the last ones at the party and didn’t notice that everyone else left the room until the music was shut off!
You are correct. Your portfolio is not reflective of what you see in the headlines, and has not surged ahead like the US equities as measured by the S&P 500. But, then again would you want a portfolio consisting only of US stocks? What if the Fed raised interest rates or stopped buying up bonds? Would you be fearful that a market correction could occur, wiping away all of your gains (or most of them)?
In effect, a portfolio consisting too much of any asset class would be, as a result, taking on excess risk. We work with our clients to diversify their portfolios to lower risk and volatility. In case some asset class declines, the other asset classes can support the ones in declines. We are maintaining diverse portfolios for our clients in order to spread risk out and try to minimize volatility.
Investment risk comes in many forms and is talked about so frequently within the industry, that every type of risk has it’s own name. Just a few are longevity risk, inflation risk, interest rate risk, liquidity risk, political risk, and market risk. This post is not about the risks themselves, rather, it is about the factors that affect our response to the risk and why it may differ from our spouse’s risk tolerance – It’s what contributes to your unique perception of risk.
Usually, when spouses disagree over how aggressive or conservative they want to be with their portfolio, the disagreement can boil down to a few key factors that can influence risk. Below are a list of some of the most common factors that influence our feelings toward risk in general.
Trust: The more trust an investor has in their financial plan, their advisor, the markets, their specific holdings, etc, the less afraid they will be.
Risk/benefit: investors who can weigh the benefits of taking on certain level of risk., the investor may be less fearful of the perceived risks if the perceived benefit outweighs the risks. Millions of people living along the ocean are taking a risk of having their homes flooded. And yet they are highly desirable pieces of property.
Control: The more control or the feeling of control an investor has over the outcome, the less likely they are to be fearful.
Choice: Risk that is imposed on us tends to cause more fear than risk we chose for ourselves.
Uncertainty: This comes as no big surprise, not knowing the likelihood of the risk occurring can cause more fear than actually knowing the likelihood.
Natural/man made: Risk related to a natural event (storms, floods, snow) tend to cause less fear than man-made events (wars).
Horror: The scarier the event, the more fear it causes. A traumatic death is much scarier than a death caused by a sudden heart attack.
Catastrophic/Chronic: Temporary events that cause lots of damage to a small population causes more fear than small amounts of damage caused over time to a large population. Think about how much more damage is caused by pollution or heart disease, and yet we are more afraid of a house fire, car accident, or terrorism. Many investors are more concerned about the sudden market drops, yet completely unaware of the bigger and ever present issue of inflation.
New/familiar: A new risk tends to cause more fear than a risk we’ve been subject to for years. Over time and with more experience and familiarity, the fear of the risk can subside.
Personalization and fairness: risks that affect people we know, children, the poor or the vulnerable tend to evoke a strong negative response.
Awareness: Lastly, simply being aware of the risk raises the level of fear. Knowing that it could happen after reading about it in the news, tends to elevate fears.
These perceptions are constantly changing based on our experiences and as events unfold. As you read this, you may find yourself thinking that a few of these perceptions affect you more than the others, but a whole new set of perceptions could become important if the markets changed.
It is our experience that many of these perceptions have a negative effect on investment decisions. All too often, these perceptions cause investors to sell out at the bottom of a temporary market decline. Investors make their decisions out of fear and emotions rather than facts. Understanding the root cause or key characteristic that drives investor fear and then finding a way to overcome and solve that fear is the first step a fearful investor should take when thinking about getting back into the market.