Taming Your Inner Biases for Better Performance
Contributed by Doug Walters, David Lemire, Max Berkovich
What a difference a week makes! The stock market erased three weeks of losses in just a few days. Patient investors knew a week like this would come eventually, while the impatient may have locked in permanent losses. As we have said many times, market timing does not pay off, and its negative impacts can compound over time.
There are so many counterproductive behavioral biases that kick in when markets decline. Many push investors to try their hand at timing the market, as we discussed in our whitepaper (Market Timing: Investing or Gambling?). Some of these biases include:
Action bias
this feeling that you must “do something” even though often the best action is no action.
Overconfidence
the belief that somehow you alone know something that the millions of market participants have yet to figure out.
Loss Aversion
the enhanced emotions we feel when facing loss versus the subdued emotions of gain (see our recent article).
The costs can compound over time for those who give in to these temptations. How so? Let’s take this past week, for example. Suppose the previous seven weeks of market declines finally pushed you over the edge, and you decided to sell all of your stocks for cash. To your dismay, the stock market rallied 6.6% this week as you watched from the sidelines before cutting your losses and jumping back in.
Let’s see how that unfortunate scenario plays out in dollars (assuming a $1,000,000 portfolio).
- Your $1,000,000 sat on the sidelines, so it remained at $1,000,000 at the end of the week.
- Had you stayed invested, your portfolio would have increased by $66,000.
So a $66,000 mistake, right? Not precisely, thanks to compounding. Long-term investors love compounding! If your stock portfolio grows 9% per year, the dollar value of growth accelerates over time. Unfortunately, the same applies to missed opportunities. That $66,000 that you could have had if you were fully invested this week would have likely grown significantly in time. How much? $66,000 growing at 9% per year would reach:
- $150,000 in 10 years,
- $370,000 in 20 years,
- $875,000 in 30 years.
Yikes! Market timing can be costly. But knowing is half the battle. Being aware of these innate biases that we all have as humans allows us to take control of them through process and discipline.
The S&P 500 ended the week up over 6%! Not bad for the first positive week in the past eight. This performance was against the grain of the Federal Reserve Open Market Committee (FOMC) meeting notes which flagged that they may need to move faster than anticipated on rate increases. However, our headline of the week is the fresh read we received on inflation.
A Better Trend
The Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) Deflator, came out this week in line with expectations. More importantly, the year-on-year measure fell.
- As measured by PCE, inflation fell from an annual rate of 6.8% in March to 6.5% in April.
- Core inflation (excluding food and energy) fell from 5.2% to 4.9%.
- These are still high numbers, but the trend is finally in the right direction.
- The Fed’s primary motivation for beginning to put the brakes on the economy is inflation, so this trend is encouraging and will be closely watched in the months ahead.
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