Last week on March 1, 2017, the Dow Jones Industrial Average (DJIA) crested 21,000 points on its index—yet another all-time-high. Since President Trump won the election on November 8, 2016, this same index is up more than 15%. And since last year’s scary start where this index bottomed out at 15,973 on February 12, 2016, the index has climbed more than 30%!
I don’t normally start out by citing milestones made by a stock index. But this time, I wanted to bring to light some observations made over the past several years of dismal returns, the mindset of investors in general, and how they have reacted to such investment related news.
When you open up your account statement each quarter, do you expect to see an increase in the value of your investments? Of course you do! That’s because most people feel that since their money is NOT sitting in a bank savings account guaranteed by FDIC, the assumed risk of an investment should be commensurate with the returns in a non-guaranteed investment. However, investors of this mindset are failing to realize one very important aspect of investing: While risk is generally equal to reward, risk is also equal to the measurement of volatility. And volatility, my friends, is normal and expected.
At the beginning of last year (2016) during the abrupt fall off in stock prices, I heard many investors (a few of my own clients, but many multiples more who were not clients) talking about wanting to take their money out of the stock market because they didn’t want to watch their assets decline again like it was the year 2000, 2001, 2002, or even 2008.
When probing deeper into their investment mindset, I would ask them what they were expecting their investments to do over any given period of time and why they were investing in the stock market in the first place. The answers ranged from, “because I want my account to grow so I can retire more comfortably” to “my bank is paying next to nothing for CDs and savings accounts.”
Therein lies the investment quandary. Returns typically have a positive correlation with the amount of risk taken, and risk is symbiotic with volatility. The DJIA has not had a correction or significant decline in more than seven-years. As people are getting used to seeing their investments ‘only go up,’ this is creating a distorted and dangerous expectation that this is normal. In contrast, an investor should expect to see his/her portfolio move both up AND down throughout various periods of time. A great explanation for this phenomenon is provided by Wikinnvest: Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves
It really shouldn’t come as a surprise that I haven’t received many calls from clients over the past few months in regards to accounts and indices being at all-time-highs. It should also be noted that I don’t, nor would I, expect any calls of that nature. However, it is this personal and ‘real’ observation that I have witnessed from my vantage point that most humans strive for and expect only positive momentum in life, investments, and their personal objectives. While people can and should remain optimistic, being realistic and focusing on the long run helps to set expectations accordingly.
I’ve stated before that I cannot take full credit for an investment’s performance that is setting new highs. And I also would not accept blame for an investment that is down 10, 15, or 20% over a one year period if this was the range of expected volatility prior to investing in it. Both of these ‘highs’ and ‘lows’ are normal occurring events, and they cannot be timed or known. Remember, “You cannot accurately time the market, but you CAN be a participant in it for as long as you want.”
So, if you feel that a call would be warranted to inquire about a drop in the value of your portfolio, but not necessarily warranted for times when your portfolio is setting new ‘highs,’ we need to talk now. My goal is to set realistic expectations for you as the investor, and not to take credit for the sun rising in the morning. I’ll leave that to the guy who has the answers to everything!