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I’m Dreaming…of an Unbiased Christmas

Thomas BalisDecember 4, 2019

Markets

As we enter the holiday season, we observe that Christmas has noticeably come early for investors this year.  November was the best month of 2019 for equity investors, and on the whole, this has been a year of strong investment performance for most asset classes.  Through November, the U.S. stock market is up 25% (as measured by the S&P 500 Index).  International equities are up 18% (as measured by the MSCI EAFE Index), and U.S. bonds are up more than 8% (as measured by the Bloomberg Barclays U.S. Aggregate Bond Index).  Clearly, Santa has chosen to replace last year’s lump of coal with many happy returns for investors who stayed invested despite 2018’s fourth quarter market dip.

Clients have had varied reactions to this year’s rally, driven in part by a variety of behavioral finance biases.   Some clients have become worried about the market becoming too frothy or overvalued, fearing an imminent pullback.  This can be due to loss aversion; the phenomenon of feeling more of the pain of losses than the pleasure of gains.  Simply put, an investor feels more pain from losing $100 than the pleasure of gaining $100.  As humans, we often seek to avoid pain, and fear of this pain can sometimes lead to poor investment decisions.

Other clients believe the market has legs, and will continue the strong gains we’ve seen this year. This can be due to recency bias, the phenomenon of remembering something that has happened recently compared to something in the more distant past.  Yet, other clients want to take on a more aggressive allocation while the market is hot. Perhaps this comes from overconfidence bias and underestimating the downside risks of investing more aggressively.

These are just some of the two dozen or so behavioral finance biases that can impact how we feel about our investment portfolios.  At HFA, we follow a rules-based approach to investing which strives to remove the bias and emotions from investment decisions. That’s why we rebalance portfolios when the asset allocation drifts too far from the portfolio’s strategic allocation target.  When a variance exceeds certain tolerance guidelines, we trim overweight areas (selling high), and add to underweight areas (buying low).   It’s nearly impossible to consistently predict market tops and bottoms, and a rules-based approach that takes profits and invests in undervalued parts of the market reduces the likelihood of bad timing errors.

If you asked experts a year ago what the market would do this year, you would have been hard pressed to find one who said it would be up 25%.  There’s no guaranteed prediction for what 2020 may bring, but its unlikely to be a repeat of 2019.  Investors should always temper expectations, knowing there will be good years, great years and, yes, even a few bad years. Over the long haul, a diversified portfolio of equities and fixed income won’t return 25%; it will probably be more like 5 or 6% for the average investor.

For now, we can be grateful for a supportive Federal Reserve, and a market that frequently seems able to shrug off ongoing trade tensions.   If market volatility has your behavioral biases in high gear, or if you just have questions or need help, reach out to our office at 610-651-2777, and ask to speak to your advisor.  We are ready, willing, and able to help you navigate through all conditions. Happy Holidays.

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