Notes, Views, and the Occasional Provocation January / February 2013 

Investors have always become disenchanted with the markets after severe downturns. But they generally started investing more capital once the markets picked back up. Not this time around. There are many possible explanations, among them more market turbulence than in the past and a need for people nearing retirement to take on less risk.

An equally plausible theory is simply this: investors are watching their portfolio results more than ever before. This seemingly benign pastime, as the behavioral psychologists have taught us, can have a pernicious effect on investor actions. Fortunately, the cure is rather mild and can lead to many more pleasant moments of calm recollection – and better payouts.

Best regards,

Milo Benningfield

More Is Not Better When Watching Portfolio Results
When it comes to portfolios, the more one looks, the worse things get for many investors. But not because of the markets. more

BFA Media Quotes
Recent media quotes. more

More Is Not Better When Watching Portfolio Results
Living one's investment life in the daily market trenches makes no more sense for long-term investors than checking the latest earthquake alerts before leaving the house each morning. This fact hit me with full force recently after I spent a couple of days periodically checking the real-time earthquake alerts at the United States Geological Survey website. With over a million earthquakes around the world each year, there's a new dot dropping on the global map every half hour or so, reminding us that we walk around not so much on solid ground as on the crusty cheese topping of a French onion soup.

Fortunately, we do not live in a world of continuous earthquake alerts. There are no websites such as Yahoo! or Google Finance publishing the USGS data and providing endless commentary and prognostications on what the current tremors mean for the likelihood of the crust's next movement.

Unfortunately, investors don't have it so good. Bombarded every minute of every day with data, charts and headlines, market news can't help but seep vaguely into their consciousness. And the news lately hasn't been cheerful. Phrases like financial crisis, sovereign debt, flash crash, and debt ceiling provoke a constant awareness that markets and economies are under threat.

Meanwhile, technology has abetted the investment-data onslaught, with new services arriving monthly it seems, offering to monitor portfolios and provide daily summaries of performance activity. What could be wrong with more information, you ask? Well, the more often one looks at a portfolio, the more likely one is to see losses, since the number of negative days in the market outnumber the positive ones. The markets earn most of their overall returns in short bursts here and there throughout the year.

The more losses an investor sees, the more tempted they are to take action. That action, unfortunately, is typically the opposite of what's required to protect investors' best interests. Let me explain.

One of the key findings of behavioral economics has been that the pain we feel from losses is about twice as great as the pleasure we feel from experiencing a gain. Psychologists Daniel Kahneman and Amos Tversky named this bias "loss aversion."

There are different forms of loss aversion. "Myopic loss aversion" is a form where our greater sensitivity to losses is compounded by frequent examination of outcomes. Not surprisingly, one well-publicized study found that the more frequently people checked their portfolio results, the more risk averse they became over time and the more likely they were to feel compelled to make portfolio changes.

Myopic loss aversion abetted by the proliferation of data feeds and continuous market news may partially explain why so many investors have missed the tremendous investment returns over the past several years. While the U.S. stock market advanced 129% since March 2009, investors overwhelmingly moved into cash and bonds. During that time, they poured more than $1.2 trillion into bond mutual funds, but less than one-tenth of that, or about $91 million, into stock funds, missing a lifetime of stock returns.

Yes, you may be saying, but the markets have been pretty scary these past four years. Absolutely. By a variety of measures, the markets have been more turbulent and prone to large daily declines over the past decade than in the previous half century.

But as strange and tumultuous as the past few years have been for the markets, when we step back and look at the larger picture, we see that the stock market recovered from its latest crash pretty much on schedule compared to past crashes. Take a look at the major U.S. market declines and recoveries over approximately the last hundred years:

Big U.S. Market Crashes*
Peak Month Trough Month Loss at Trough Recovery Month Years to Recovery
Oct 2007
Feb 2009
Mar 2012
Mar 2000
Sep 2002
Oct 2006
Aug 1987
Nov 1987
May 1989
Dec 1972
Dec 1974
Jun 1976
Dec 1961
Jun 1962
Apr 1963
Feb 1937
Mar 1938
Mar 1944
Aug 1929
Jun 1932
Jan 1945
*Market cycles based on month-end value of S&P 500 Index with reinvested dividends; data courtesy of Dimensional Fund Advisors.

Yes, the decline of over 50% for U.S. stocks was sharp, and recovery on the other side a little steeper than some recoveries. But the results, historically speaking, appear to be largely within normal limits and a far cry from the allegations that the recovery of the past four years was merely a mirage destined to end in more unhappiness.

If anything, the chart above acknowledges that big market crashes, like major earthquakes, are simply part of the terrain where we live. This is why we retrofit our portfolios in advance, after careful consideration, then sit tight when the house is shaking. Staying focused on this big picture, rather than the daily market tremors, is one of the most important secrets to investment success.

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BFA Media Quotes
Wall Street Journal, January 29, 2013
Milo was quoted in an article by Ian Salisbury, "This Year, Getting Knocked Off Balance May Be A Good Thing," which discussed how some professional investors are questioning their portfolio rebalancing strategies given the large recent stock gains. Milo noted that he was avoiding changes because of market moves. He acknowledged that "[r]ebalancing is 'inherently uncomfortable' since it always involves selling winners to buy losers," [but that] "The whole point of a discipline is to avoid reacting to the markets." Read the article.

Thank you for reading. Please look for our next newsletter in April.

Best regards,

Milo Benningfield

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