Front page Yahoo headline for Friday, August 19, 2011:
Wall Street Sees Worst Four-Week Drop Since March 2009
As a great radio broadcaster used to say: "The rest of the story..."
The US Total Stock Market Index for the year end 2009:
A whopping gain of 29.1%!
Moral of the story? Don't believe all the hype nor believe in all the fear. If we all traded on our emotions, we would all be in trouble.
Fine print: this is no way saying the markets are going to end the year in a great upward swing, nor is it saying the market is going to continue to drop. My crystal ball is as cloudy as yours. But what I do know, that with time, the markets have a good history of working everything out.
Friday, August 19, 2011
Monday, August 15, 2011
Discipline: Your Secret Weapon
Working with markets, understanding risk and return, diversifying and portfolio structure—we've heard the lessons of sound investing over and over. But so often the most important factor between success and failure is ourselves.
The recent rocky period in financial markets has brought to the surface some familiar emotions for many, including a strong urge to try to time the market. The temptation, as always, is to sell into falling markets and buy into rising ones.
What's more, the most seemingly "well-informed" people—the kind who religiously read the financial press and watch business television—are the ones who feel most compelled to try and finesse their exit and entry points.
This suspicion that "sophisticated" investors are the most prone to try and outwit the market was given validity recently by a study, carried out by London-based Ledbury Research, of more than 2,000 affluent people around the world.
The survey found 40 percent of those questioned admitted to practising market timing rather than pursuing a buy-and-hold strategy. Yet the market timers were more than three times more likely to believe they traded too much.
"On the face of it, you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves," the authors said. "But that seems not to be the case—trading becomes addictive."
This perspective has been reinforced recently by one of the world's most respected policymakers and astute observers of markets—Ian Macfarlane, the former governor of the Reserve Bank of Australia and now a director of ANZ Banking Group.
In a speech in Sydney, Macfarlane made the point that the worst investors tend to be those who follow markets and the financial media fanatically, extrapolating from short-term movements big picture narratives that fit their predispositions.
"Most people experience loss aversion," he said. "They experience more unhappiness from losing $100 than they gain in happiness from acquiring $100. So the more often they are made aware of a loss, the unhappier they become."
Because of this combination of hyper-activity, lack of self-control and loss-aversion, investors end up making bad investment decisions, Macfarlane noted.
These behavioral issues and the impact on investors are well documented by financial theorists. Commonly cited traits include lack of diversification, excessive trading, an obstinate reluctance to sell losers and buying on past performance.
Mostly, these traits stem from over-confidence. Just as we all tend to think we are above-average in terms of driving ability, we also tend to over-rate our capacity for beating the market. What's more, this ego-driven behavior has been shown to be more prevalent in men than in women.
A study quoted in The Wall Street Journal showed women are less afflicted than men by over-confidence and are more likely to attribute success in investment to factors outside themselves – like luck or fate. As a result, they are more inclined to exercise self-discipline and to avoid trying to time the market.
The virtues of investment discipline and the folly of 'alpha'-chasing are highlighted year after year in the survey of investor behavior by research group Dalbar. The latest edition showed in the 20 years to the end of December 2010, the average US stock investor received annualized returns of just 3.8 percent, well below the 9.1 percent delivered by the market index, the S&P 500.
What often stops investors getting returns that are there for the taking are their very own actions—lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.
So how do we get our egos and emotions out of the investment process? One answer is to distance ourselves from the daily noise by appointing a financial advisor to help stop us doing things against our own long-term interests.
An advisor begins with the understanding that there are things we can't control (like the ups and downs in the markets) and things we can. Some of the things we can control including ensuring our investments are properly diversified—both within and across asset classes—ensuring our portfolios are regularly rebalanced to meet our long-term requirements, keeping costs to a minimum and being mindful of taxes.
Most of all, an advisor helps us all by encouraging the exercise of discipline—the secret weapon in building long-term wealth.
The recent rocky period in financial markets has brought to the surface some familiar emotions for many, including a strong urge to try to time the market. The temptation, as always, is to sell into falling markets and buy into rising ones.
What's more, the most seemingly "well-informed" people—the kind who religiously read the financial press and watch business television—are the ones who feel most compelled to try and finesse their exit and entry points.
This suspicion that "sophisticated" investors are the most prone to try and outwit the market was given validity recently by a study, carried out by London-based Ledbury Research, of more than 2,000 affluent people around the world.
The survey found 40 percent of those questioned admitted to practising market timing rather than pursuing a buy-and-hold strategy. Yet the market timers were more than three times more likely to believe they traded too much.
"On the face of it, you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves," the authors said. "But that seems not to be the case—trading becomes addictive."
This perspective has been reinforced recently by one of the world's most respected policymakers and astute observers of markets—Ian Macfarlane, the former governor of the Reserve Bank of Australia and now a director of ANZ Banking Group.
In a speech in Sydney, Macfarlane made the point that the worst investors tend to be those who follow markets and the financial media fanatically, extrapolating from short-term movements big picture narratives that fit their predispositions.
"Most people experience loss aversion," he said. "They experience more unhappiness from losing $100 than they gain in happiness from acquiring $100. So the more often they are made aware of a loss, the unhappier they become."
Because of this combination of hyper-activity, lack of self-control and loss-aversion, investors end up making bad investment decisions, Macfarlane noted.
These behavioral issues and the impact on investors are well documented by financial theorists. Commonly cited traits include lack of diversification, excessive trading, an obstinate reluctance to sell losers and buying on past performance.
Mostly, these traits stem from over-confidence. Just as we all tend to think we are above-average in terms of driving ability, we also tend to over-rate our capacity for beating the market. What's more, this ego-driven behavior has been shown to be more prevalent in men than in women.
A study quoted in The Wall Street Journal showed women are less afflicted than men by over-confidence and are more likely to attribute success in investment to factors outside themselves – like luck or fate. As a result, they are more inclined to exercise self-discipline and to avoid trying to time the market.
The virtues of investment discipline and the folly of 'alpha'-chasing are highlighted year after year in the survey of investor behavior by research group Dalbar. The latest edition showed in the 20 years to the end of December 2010, the average US stock investor received annualized returns of just 3.8 percent, well below the 9.1 percent delivered by the market index, the S&P 500.
What often stops investors getting returns that are there for the taking are their very own actions—lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.
So how do we get our egos and emotions out of the investment process? One answer is to distance ourselves from the daily noise by appointing a financial advisor to help stop us doing things against our own long-term interests.
An advisor begins with the understanding that there are things we can't control (like the ups and downs in the markets) and things we can. Some of the things we can control including ensuring our investments are properly diversified—both within and across asset classes—ensuring our portfolios are regularly rebalanced to meet our long-term requirements, keeping costs to a minimum and being mindful of taxes.
Most of all, an advisor helps us all by encouraging the exercise of discipline—the secret weapon in building long-term wealth.
Seven Headlines to Beat the Gloom
Debt crises, sovereign risks, double dips and banking strains: Page One headlines can make for depressing reading these days. But being a smart news consumer—and smart investor—means keeping an eye on the lesser headlines. Here are seven you may not have seen:
Australia, for instance, is enjoying its best terms of trade in more than 50 years. An unprecedented investment boom in mining is injecting extraordinary wealth into the economy and has helped to push the Australian dollar to levels not seen since it was floated in the early 1980s. Likewise, China, India and much of South-East Asia are seeing strong investment flows and worrying more about over-heating than anything.
This is not to say that all is right with the world. The aftermath of the global financial crisis has created severe problems, particularly in terms of public sector debt and deficits. But we know that that news is in the price. Meanwhile, economic activity in much of the world is thriving.
For equity investors, that means opportunities for wealth building are increasing, not decreasing. Moreover, the global economy is becoming multi-polar, rather than overly dependent on the US, which means the potential benefits from broad diversification are even greater. That's why focusing too much on the day-to-day headlines with the US debt ceiling or European sovereign issues risks missing many of the good stories out there.
Sometimes, the best advice is to read the newspaper from the inside out.
- Robust Growth in Germany Pushes Prices—Analysts see a strong chance that German inflation will head towards 3 per cent by the end of the year against a backdrop of robust growth in Europe's biggest economy. (Reuters, July, 27, 2011)
- Brazil Domestic Demand Still Strong—The Economist Intelligence Unit says economic growth in Brazil surprisingly picked up speed in the first quarter, challenging the government’s efforts to cool the expansion. (EIU, July 6, 2011)
- Japan Retail Sales Top Estimates—Japan's retail sales rose 1.1 per cent in June, exceeding all economists' forecasts and adding to signs the economy is bouncing back from an initial post-disaster plunge. (Bloomberg, July 28, 2011)
- No Fear in China—Traders betting on gains in China's biggest companies are pushing options prices to the most bullish level in two years. The Chinese economy is projected to grow by 9.4 per cent in 2011. (Bloomberg, July 28, 2011)
- Southeast Asia Booms—Southeast Asian markets are the world's top performers in 2011 thanks to strong economic and corporate fundamentals. Thailand's index hit a 15-year high in July and Indonesia's a record high. (Reuters, July 22, 2011)
- Australian Boom Keeps Rate Rise on the Agenda—The Australian dollar hit its highest level in 30 years in late July as traders looked to the prospect of another rise in interest rates on the back of a resource investment boom. (WSJ, July 27, 2011)
- NZ Bounces Back—The New Zealand economy has grown more strongly than expected after the Christchurch earthquake, helped by improving terms of trade. The Reserve Bank signals it may raise interest rates soon. (Bloomberg, July 28, 2011)
Australia, for instance, is enjoying its best terms of trade in more than 50 years. An unprecedented investment boom in mining is injecting extraordinary wealth into the economy and has helped to push the Australian dollar to levels not seen since it was floated in the early 1980s. Likewise, China, India and much of South-East Asia are seeing strong investment flows and worrying more about over-heating than anything.
This is not to say that all is right with the world. The aftermath of the global financial crisis has created severe problems, particularly in terms of public sector debt and deficits. But we know that that news is in the price. Meanwhile, economic activity in much of the world is thriving.
For equity investors, that means opportunities for wealth building are increasing, not decreasing. Moreover, the global economy is becoming multi-polar, rather than overly dependent on the US, which means the potential benefits from broad diversification are even greater. That's why focusing too much on the day-to-day headlines with the US debt ceiling or European sovereign issues risks missing many of the good stories out there.
Sometimes, the best advice is to read the newspaper from the inside out.
The Current Market Aftershock
Using an illustrated timeline, David Booth (Chairman and Co-Chief Executive Officer, Dimensional Fund Advisors) chronicles US stock market performance in four periods since World War II. His review suggests prevailing market sentiment is often wrong and that investors must stay disciplined through all market environments to pursue their long-term goals.
click to play
Recent Market Volatility
The current renewed volatility in financial markets is reviving unwelcome feelings among many investors—feelings of anxiety, fear, and a sense of powerlessness. These are completely natural responses. Acting on those emotions, though, can end up doing us more harm than good. At base, the increase in market volatility is an expression of uncertainty. The sovereign debt strains in the US and Europe, together with renewed worries over financial institutions and fears of another recession, are leading market participants to apply a higher discount to risky assets. So, developed world equities, oil and industrial commodities, emerging markets, and commodity-related currencies are weakening as risk aversion drives investors to the perceived safe havens of government bonds, gold, and other commodity type investments.
Over the past two weeks, we’ve seen events reminiscent of 2008, when the collapse of Lehman Brothers and the sub-prime mortgage crisis triggered a global market correction. This time, however, the focus of concern has turned from private-sector to public-sector balance sheets. In this email, I want to try to address a few points and summarize my thoughts on what has been happening. As to what happens next, no one knows for sure. That is the nature of risk. But here are a few points all investors need to keep in mind to make living with this volatility more bearable:
- Remember that markets are unpredictable and do not always react the way the experts predict they will. The recent downgrade by Standard & Poor's of the US government's credit rating, following protracted and painful negotiations on extending its debt ceiling, actually led to a strengthening in Treasury bonds.
- Quitting the equity market at a time like this is like running away from a sale. While prices have been discounted to reflect higher risk, that's another way of saying expected returns are higher. And while the media headlines proclaim that "investors are dumping stocks," remember someone is buying them. Those people are often the long-term investors.
- Market recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was last this bad—the S&P 500 turned and put in seven consecutive months of gains totaling almost 80 percent. This is not to predict that a similarly vertically shaped recovery is in the cards this time, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery.
- Never forget the power of diversification. While equity markets have had a rocky time in 2011, fixed income markets have flourished—making the overall losses to balanced fund investors a little more bearable. Diversification spreads risk and can lessen the bumps in the road. This is why portfolios at Arcon Wealth Management consists of over 10,000 stock holdings spread across separate asset classes in over 40 countries around the world.
- Markets and economies are different things. The world economy is forever changing, and new forces are replacing old ones. As the IMF noted recently, while advanced economies seek to repair public and financial balance sheets, emerging market economies are thriving. A globally diversified portfolio takes account of these shifts.
- Nothing lasts forever. Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy. So too is a well developed plan that takes risks and volatility into consideration. Thus the reason our financial plans are built around both very good times as well as very bad economic times. Anything else is just not prudent planning.
Subscribe to:
Posts (Atom)