What a wild and crazy year 2020 has been. The fortitude of most investors has already been tested multiple times, and with the election only a few weeks away, many will continue to have their blood pressure and risk tolerance tested.
With the rise of behavioral economics, there have been many studies done on emotional decisions that cost investors millions of dollars. One of the most common and detrimental mistakes that investors can make is letting short-term volatility divert their focus from their long-term plan. In psychological terms, this is called Myopic Loss Aversion. Simply put, Myopic Loss Aversion states that the pain of losses, even in the short-term, are more impactful on an investor’s behavior than the benefit of the long-term gains that the market has delivered time and time again.
Consider the last 18 months; investors were handsomely rewarded in 2019 with well above average returns, however, when the COVID-19 induced selloff occurred in February and March, those handsome returns were quickly forgotten. Investors, almost universally, hold on tightly to their “high water mark” as a point of reference during any period of loss.
If we can shift the focus away from the short-term, history has proven that time is on our side. When looking back at the returns of the S&P 500 since 1928 the market has about a 53% probability of being positive on any given day. If we expand that to monthly, the probability of the S&P 500 being up jumps to 63%, and on an annual basis the S&P 500 has been positive 73% of the time. If we extend the time period out to 5 years, the S&P 500 has been positive 88% of the time.
I am reminded of the Great Recession of 2008 and 2009 when Real Estate prices, almost across the board, took a hit as the banks struggled with bad loans. During this time, I did not speak with a single client who wanted to sell any of their real estate. Why? Real Estate is not valued daily and in many cases is not even valued annually. The lack of “feedback” lets investors comfortably maintain their real estate holdings.
Why is this important one might ask? The greatest amplifier of Myopic Loss Aversion is frequent feedback. The talking heads, scrolling stock tickers, and phone apps make it all too easy for us to know exactly what our investments are doing each second of the day. The less often we look, the less likely we are to make decisions today that cost us in the long run.
As advisors, we spend the bulk of our time mapping out long-term plans for our clients, only to then see clients throw all of that out the window when the markets get skittish. As we go into what could be a volatile end of the year, keep the focus on your long-term goals and plans, do not chose short-term relief for long-term regret.
The statements and opinions expressed herein are subject to change without notice based on market and other conditions. The information provided is for informational purposes only and should not be construed as investment or legal opinion. Please consult a tax or financial advisor with questions about your specific situation. Investors may not invest directly in an unmanaged index. Past performance is not a guarantee of future returns.