How retirees should navigate this bear market
Here’s the best way to play the market for the rest of 2022: Don’t look.
I offer this advice not because I believe the bear market will continue, although of course it may. I would give the same advice if I thought the next leg of the bull market is about to begin.
The reason for not looking is that “looking” is not a benign act. It actually changes your behavior, often in destructive ways.
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I was prompted to make this observation by a fascinating recent study that has begun circulating in academic circles. The study, “Unpacking the Rise in Alternatives,” was conducted by Juliane Begenau of Stanford and Pauline Liang and Emil Siriwardane of Harvard. This study focuses on a relatively obscure feature of the investment industry – the sharp increase over the past two decades in the average allocation of pension funds to so-called alternative investments such as hedge funds and private equity. . But what the researchers found has implications for all of us.
Applying a series of complex statistical tests, they concluded that a key determinant of a given pension fund’s decision to establish an allocation to alternative investments was whether other pension funds in the same geographical area were doing it themselves. In other words, if a pension fund in a given region launched a large allocation to alternative investments, then there was a greater chance that others nearby would follow suit.
Good old peer pressure, in other words. So much for the so-called independent analysis carried out by the very expensive analysts and consultants employed by pension funds.
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The reason it concerns all of us: If these investment experts are unable to think independently, it’s even less likely that any of us will be able to. And that can be expensive. Going against the grain, for example, citing only one popular strategy, forces us to go against the consensus. Insofar as we are constantly looking over our shoulders to see what others are doing, then being a true maverick becomes even more difficult than it already is.
This reminds me of the classic observation of the late British economist and philosopher John Maynard Keynes: we would rather “fail conventionally than…succeed unconventionally”.
Myopic loss aversion
Peer pressure is just one reason why we should reduce the frequency with which we focus on short-term market movements and the evolution of our portfolios. Another major problem is known as Myopic Loss Aversion (MLA).
MLA exists for two reasons. First, we hate losses more than we love gains, and it’s hard to resist checking the performance of our portfolios. Therefore, when we check the net worth of our portfolio more frequently, we will have a higher subjective perception of risk. This, in turn, results in a lower allocation to riskier investments, the very ones that generally produce better long-term returns.
The discovery of MLA dates back to research conducted in the early 1990s by Shlomo Benartzi, professor and chairman of the Behavioral Decision-Making Group at UCLA Anderson School of Management, and Richard Thaler, professor of behavioral science and economics at the University of Chicago Booth School of Business (and winner of the 2015 Nobel Prize in Economics). Since then, the existence of MLA has been confirmed by numerous studies.
One of the most revealing compared the performance of professional traders to two different groups: those who focused on their portfolio’s performance second by second and those who checked every four hours. Those in the latter group “invest 33% more in risky assets, generating 53% higher profits, compared to traders who receive frequent price information,” according to the study.
I doubt any of you are checking the status of your portfolio every second of the trading day, although I know some of you are about to. But the study specifies the general pattern.
To use an example more relevant to the typical retail investor, imagine Rip van Winkle falling asleep early last year, 18 months ago, checking the SPX of the S&P 500,
level just before he dozed off. If he were to wake up today and check the market, he would probably yawn and fall asleep again. On a price-only basis, the S&P 500 has gained 1.1% since the start of last year and 3.3% on a total return basis.
On the other hand, if Rip Van Winkle woke up every month and checked his wallet, he would now have motion sickness. The S&P 500 produced a total return of 5.9% in its best month since the start of 2021 and lost 9.0% in its worst month.
My illustration of Rip Van Winkle isn’t as hypothetical as you might otherwise think. In 2010, Israel implemented a regulatory change prohibiting mutual fund companies from reporting returns for any period less than 12 months. Prior to this change, one-month returns featured prominently in client statements. A 2017 study by Maya Shaton, an economist with the Federal Reserve’s Banking and Financial Analysis Section, found that regulatory change “resulted in a reduction in the sensitivity of funds flows to past returns, a decline in the volume exchanges and an increase in asset allocation to riskier funds. .”
“Not looking” may be unrealistic…
However, taking your eyes off the market and your brokerage statement may be asking too much, especially given the recent extraordinary volatility in the markets and the near saturation of that volatility in the financial press. If this is true for you, then you need to figure out how to stay disciplined by sticking to your predefined financial plan while following the short-term swings of the markets.
What that looks like in your particular situation will depend on your personality. This may require entrusting day-to-day control of your portfolio to an investment advisor who is instructed never to deviate from your predetermined financial plan. Another possibility would be to invest only in mutual funds that limit how often you can trade. Another solution would be to work with your brokerage firm, IRA or 401(k) sponsor, or advisor to both reduce the frequency with which they report your performance and increase the length of the periods over which they report performance.
When considering what would be needed, it helps to remember what Odysseus of Greek myth did to be able to listen to the beautiful siren song. He knew he would be unable to resist their seductive songs, yet he also knew that succumbing to this temptation would be fatal. So he had his men tied to the mast of the ship he was sailing on so he could listen. Our job is to find the modern equivalent of tying ourselves to the mast.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected].