The Wall of Worry
The last eight years have been a good period for equity investing. But can it last? As the old saying goes, “Markets climb a wall of worry.” There is certainly plenty to worry about: looming market corrections, elections in Europe, and political uncertainty.
In reviewing the last eight years, we find plenty of dramatic world events that could have caused an abrupt end to the bull market. Looking at the chart below, anyone could be forgiven for wanting to get out of the market at many points. However, doing so would have resulted in forgoing significant returns.
S&P 500 TOTAL RETURN INDEX WITH SELECTED HEADLINES (January 1, 2009 – April 30, 2017)
Source: S&P Dow Jones Indices LLC
When markets are positive for an extended period, investors begin to wonder how long it will last. They constantly fret about whether some event is going to turn into a market rout and agonize over whether they should stay invested or head for the sidelines.
Of course, pundits and commentators fuel the fire by issuing warnings about everything that could possibly go wrong with the world, the economy, markets and high-profile stocks. Meanwhile, economists and experts give conflicting predictions from the same data. Altogether, these potentially unsettling world events are amplified by opinion and media hype.
But for all the resulting sound and fury, usually the right thing to do is to stay fully invested. It’s not that these events are not real or don’t matter, it’s just that reacting to them should not be the basis for long-term investment decisions. History has also shown that the US economy and stock market are incredibly resilient with the capacity to weather them. While pullbacks are inevitable, the best course of action is to stay focused on fundamentals and your long-term goals.
From the Behavioral Viewpoint
What is going on?
- Events and the constant chatter about them create a negative availability bias, in which a never-ending stream of dramatic events have the potential to dramatically change everything. While this is good for cable ratings and social media clicks, it creates anxiety for investors.
- Pundits and media opinion trigger our social validation and herding instincts. Where we are on the lookout for something dangerous and should be prepared to flee. While useful on the Serengeti, this is not particularly helpful in making sound investment decisions.
- Any discussion about potential negative performance can trigger loss aversion, in which we feel twice as bad about a loss as we do a comparable gain. This fear is powerful and can cause investors to make poor decisions that are counterproductive to their long-term goals.
- We overestimate our abilities to determine both the best time to exit and to get back into the market. On the other hand, we underestimate the true randomness of world events. This overconfidence bias results in emotional selling and missing out on subsequent returns.
What can we do?
- The key to ignoring the constant chatter and media hype is to have a disciplined approach that keeps your emotions in check. Of Course, turning off the media and going outside also helps.
- Use needs based planning to separate short and long-term investments. This can insulate your emotions from short-term market volatility while allowing long-term investments the time they need to mature.
- An experienced financial advisor, who has lived through many market environments, can also provide valuable perspective and coaching that can help you stick to the plan and stay focused on long-term goals.
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