Bruising. That’s how some news outlets characterized the markets at the end of 2018. Others noted that 2018 was the worst year for investors since 2008, as both the Nasdaq Composite Index and Russell 2000 entered bear-market territory and the S&P 500 inched to within a hair’s breadth.
The truth is, however, we had three good quarters before Q4 started its year-end nosedive. And that got me thinking about…superlatives, oddly enough.
What if Charles Dickens had begun his classic “Tale of Two Cities” as follows: It wasn’t the best of times, it wasn’t the worst of times, it was the usual mixed bag.
While the statement may reflect reality, it doesn’t grab your attention half as well as Dickens’ actual opening sentence describing the French Revolution. As he concluded about the period, “some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”
Best! Worst! Delight! Despair! These are the sentiments that fuel our dreams and inspire our works of art. They also make for great headlines, like many of the ones we saw describing the markets toward the end of December. But you do yourself a disservice if you allow superlatives to rule your investing. In capital markets, it’s hard to avoid getting caught up in extremes and devaluing the sweeping tides of time – our hidden brain is working against our best future interest in the background and you risk giving up your greatest edge: a clear-eyed understanding of what’s really going on.
As we reflect on the events of 2018, here are two evidence-based points worth repeating:
- You are human; you are susceptible to recency bias.
Have you heard of the “hidden brain?” While there are many behavioral biases that trick us into sabotaging our best financial interests, we’re especially interested in the damage recency bias could cause in current conditions. This hidden brain is our fight or flight response. It’s really hard to ignore the natural instinct we have when we feel our livelihood is threatened. Our brains are wired to run or fight at the first sign of danger; after all, this past response is why humans have out-lived as a species on the planet and is on top of the food chain!
But markets and their results are different from a lion on the hunt; recency bias can trick your brain into downplaying decades of robust market performance data, while magnifying the run of unusually calm market conditions we’ve been enjoying relatively recently – essentially since March 2009. This in turn may lead you to lend more weight than is warranted to current volatility.
That’s not to say the ride will be fun if we encounter more turbulence ahead. By remembering the extremes are actually the norm in your quest to generate durable long-term returns, you stand a much better chance of preserving your objective perspective and your portfolio, come what may.
- “Average” annual investment returns aren’t typical; in fact, they’re rare.
To quote the late John Bogle, “Time is your friend; impulse is your enemy.” That’s because – to get the “average” return – you need to be in the market for a long period of time. If you think about it, what’s the definition of “average?” It’s the sum of the returns from every year, divided by the number of years in the data set. So, it’s reasonable to believe that every year will be either higher or lower than the average, but probably not equal to the average itself.
If you look at the historical S&P 500 stock market returns over a 20-year period, you’ll see that the returns for each year vary widely. As Dana Anspach of The Balance points out, the market’s down years do have an impact, but the impact degree depends on how long you stay in the market.
And yet, many “noisiest authorities” have been quick to play up the superlatives, while downplaying how these sorts of best of times, worst of timesconditions have long been more the norm than the exception in capital markets. As expressed in this Forbes column, “when you take the long view – and if you’re a long-term investor, then you should – you’ll see that what feels jarring right now is actually just a return to normal levels of short-term volatility.”
The increased volatility we saw during the fourth quarter of 2018 serves to underscore the importance of approaching investments with diversification and discipline, rather than trying to time the market. Think how difficult that would be: to predict the market successfully, you would need not only to forecast the future more accurately than every other investor; you would also need to know how other investors might react!
Instead, let’s focus on what we can control. As our friends at Dimensional Fund Advisors like to say, “While we cannot control markets, we can control how we invest.” At AMDG Financial, we’re here to help guide you through the ups and downs and keep your eyes on the prize – the goals you’ve set for your financial well-being. If you have questions or concerns about the markets anytime, please feel free to contact us. We’d be glad to explain what’s really happening behind all those superlatives.