The Dangers of Instinctive Investing
by P.J. DiNuzzo March 27, 2014
The Dangers of Instinctive Investing
You've probably read about behavioral finance research. The conclusion is generally the same, no matter what aspect of our decision-making is being probed: the human mind is hard-wired to process information in certain ways which were extremely helpful when the environment contained gazelles (very tasty!) and saber-toothed tigers (extremely dangerous!), but are not so helpful when we're navigating the unfamiliar terrain of the investment markets. People shop at the mall looking for bargain prices, rather than flocking to stores where the price tags have been constantly revised upwards for the past 12 months. But for some reason, they do the opposite when they're shopping for investments.
The research reports make it sound like ordinary investors are subject to these stupid urges, but professional financial advisors are somehow immune to them. This is far from the truth. Financial planners and advisors are better-trained to understand the markets, but we're all subject to the same primal urges and instincts. Most professional advisors looked back with some regret at the 30% returns the U.S. markets experienced last year, and wished they'd had the foresight to go all-in on stocks on January 1. That, of course, was when Congress was flirting with the fiscal cliff and a potentially-catastrophic repudiation of Treasury debt, 597 U.S. counties in 14 states were receiving disaster relief from the worst drought on record, blizzards were burying the Northeast, people were saying that the Mayan calendar predicted the end of the world and some voters were saying that the Presidential election results confirmed it.
Today, as advisors look back with envy, so too do their clients and investors. It is deeply engrained in our nature to wonder whether we should pile into stocks now while the markets are still going up. If the Russian invasion of Crimea can't stop the upward trend, then what else can?
These are sometimes the hardest conversations a professional advisor can have, for a couple of reasons. First, because it requires the advisor to admit that we really don't have a clue about what the markets are going to do next. This is true of all of every living person, of course, but shouldn't professionals have better insight into the future? It feels like we're admitting a dirty secret, when in fact the inability to see the future is a limitation we mortals all share.
The second reason this conversation is hard is because it always seems like the advisor is trying to talk people out of what they want to do. We are right at the five-year anniversary of one of the best times in history to have thrown all your money into stocks--in March 2009, right after the massive global economic meltdown, in the teeth of the Great Recession. But of course, most of the conversations at that time revolved around just the opposite decision: shouldn't I take all my money out of the market and avoid any further losses?
Instead of encouraging their clients to double-down on stocks in early March 2009, most advisors were still looking back with shock and horror. All of us were feeling our own sense of regret that somehow, some way we should have seen the meltdown coming--even though Fed economists, regulators and global leaders couldn't predict it either.
Today, as always, we have no idea where the markets are headed. All we know is that history has shown, over and over again, that when the markets have been on a long upward run, and the run seems to be accelerating, that has traditionally been a poor time to load up on stocks.
But it's fair to ask: what could derail stocks this year? Interest rates are low and likely to remain that way as long as the Federal Reserve Board intends them to--which, if we believe their pronouncements, won't be until next year at the earliest. The economy is still in recovery, but GDP gains are now in line with historical averages and trending upward. Household financial obligations (measured by the share of income needed to make payments on mortgages, leases, student loans, credit cards and auto loans) is the smallest share of income since the early 1980s. Oil and gas prices are low and trending downward. We seem, on the surface, to be facing the exact opposite conditions that we experienced at the beginning of 2013: less uncertainty, calmer economic weather.
But maybe that's the point. The current circumstances really don't tell us much about future markets movements. Stock prices jump up and down and around based on what analysts call "sentiment," which basically means all those dysfunctional behavioral finance heuristics playing out day by day, week by week, as we hunt stocks the way our ancestors hunted antelope. All we know is that over the long-term, companies in aggregate (and their stocks, in aggregate) have become increasingly valuable, due to the time and energy and ingenuity of all the workers whose daily labor creates, builds and manages this growth. Fortunately, for those who have the discipline to act on it, this information can be enough to build wealth over years of patience, while the people who try to time the markets on the upside and downside are letting this stable long-term wealth opportunity slip through their fingers.
P.J. DiNuzzo, CPA, PFS®, AIF®, MSTx, MBA
President, Founder, and Chief Investment Officer