Whenever we hit a rough patch in the markets, there is one question that likely enters the minds of clients:
What should I do?
Sometimes, a variant of that question is asked:
- Should I make any changes?
- Should anything different be done?
- Should I invest in something else?
Here’s the funny thing about asking what you should do: it implies that all that should be done has not already been done.
A negative market environment can destroy our confidence in the investments we have made, the investment strategy that has led to their selection, or even the general concept of investing. In other words, if a down market causes us to think that we might need to do something different, then that is tantamount to market outcomes dictating our confidence to us, not to mention any resulting decision.
Since when did the markets become predictable?
There is no doubt that there are certain economic, market, and even political environments in which we feel more comfortable. I think it’s fair to say that, for the average investor, it is this comfort that leads to confidence.
Feeling comfortable and confident, however, are no guarantee of how things will turn out, and we should all have enough experience under our belts to know that things can turn on a dime. Further, conflating a greater degree of confidence, or certainty, warranted or not, with absolute certainty would mean that we have determined markets to be predictable, and we should all know that’s not true.
It needs to be acknowledged that if the markets are unpredictable, they’re unpredictable, and it doesn’t matter how confident we have become. The confidence that the average investor might experience, however, is not exclusively the domain of positive thinking. In fact, I would argue that it is when things aren’t looking so good that folks exhibit the greatest degree of confidence—they just know that they are doomed.
There’s a problem with this, though: if we can’t guarantee an outcome when we feel good about things, why would our predictive abilities be any more reliable simply because we have a negative outlook? Hint: they aren’t.
Assuming that you agree, and I know you do, then we need to address why our feelings and behavior don’t always follow such a logical and reasonable path. So, why is that?
I won’t go into great detail about what, exactly, loss aversion is (the link above is a good resource) but suffice it to say that it is basically the result of losses being felt with greater magnitude than rewards—i.e., we hate to lose more than we enjoy winning.
In fact, we will work very hard, even taking on greater degrees of risk, just to avoid a loss. This would help explain the fact that I have never received a phone call from an anxious client asking if they should do something different during a positive market environment. If we are committed to being logical and reasonable, however, then it doesn’t make sense to reserve the question of whether you should do something different for certain times. If the markets are always unpredictable, then that question is basically always relevant.
The Trajectory of Assets
Now, I am about to say something that, on its face, will seem controversial, and contradictory to what I have said about the uncertainty of the markets: all asset classes that are recommended as part of a conventional portfolio have appreciated over time. If this were not true, then the asset classes available to recommend, or even the act of investing, would be greatly limited or even nonexistent. Granted, historical performance is no guarantee of future results, but it absolutely should be acknowledged that what draws us to investing is the prospect of, and our comfort level with, investments producing positive returns.
In other words, it’s akin to knowing that investments will appreciate over time, but not knowing by how much or when. What this means is that it is only a belief that this trajectory will not continue that should lead to a loss of faith in our investments, our investment strategy, or the general act of investing. Further, that belief would need to be informed by specific reasons. Otherwise, that belief, and any decision based upon it, might be misguided, and significantly so.
So, if, generally speaking, assets appreciate over time, then what is it about negative performance that concerns us so much? This really gets to the heart of risk, which we will address in the next blog, Asset Allocation & Risk Tolerance: What’s the Best Allocation for YOU?