February 5, 2019
The idea that investors are purely rational – i.e. that they do not make decisions based on emotion – has been challenged over the last decade. Behavioral finance, which acknowledges that people do not act robotically, has been vying for the crown of accepted economic theory. An example of behavioral finance is the theory that losses are felt more acutely than gains. Another is a theory called “recency bias,” which means that our memories are short, and we tend to project the recent past into the future.
After 6 years of relative calm in the markets, it is natural to get squeamish when bouts of instability occur. If you compared the market gyrations of the last several months to the placid waters of the last several years, you were indeed in for a shock. However, if you can take a step back and look at the return of the S&P 500 since March 31, 2009 through January 2019, you will notice that earnings have exceeded 15.6% per year. If you had thrown in the towel and sold all your equities at the end of December, you would have missed out on an 8% rebound.
We have long been standard bearers for the mantra that volatility matters. It can destroy long-term wealth, but we also believe that over the long run, taking some degree of risk is vital to growing your assets. Being appropriately invested may mean periods of discomfort during market volatility, but mitigating bad behavioral tendencies with a rational framework can enable you to make decisions that are right for you. Recognizing that you can change where you stand and create a healthy perspective is an important step in maintaining an appropriate investment solution. As always, thank you for reading this issue of Independent Insights. We enjoy your feedback and suggestions.
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