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Volume 2 Issue 2
|
S
upporting
Y
our
P
ractice
•
Overconfidence
Markets are unpredictable, more so than most people realize (see
Fig. 1
). In spite of this, many investors tend to overrate their ability
to time markets and pick winners.
• Status quo bias
What has been happening will continue to happen—the belief that
the market will continue to go down, or up, because that is the way
it has been trending recently.
STAYING THE COURSE
It’s the last two of these biases that tend to influence decisions in a
volatile market such as we’ve seen in recent months. While market
corrections are not a big concern for individuals investing for the long
term, a certain percentage of investors tend to get nervous when
volatility increases, and may feel compelled to move out of the equity
market in the face of a sharp decline.
Very few investments provide better capital appreciation than equities
over the long term, but you need to stay disciplined to realize those
gains. Investors who react to market conditions and change direction
mid-stream tend to fare worse than those who stay the course.
One problem with getting out of an equity market in decline is
deciding when to get back in. For example, if you had invested
$100,000 in the S&P 500 in 1993, that amount would have increased
by $483,320 by 2013 (see
Fig. 2
). However, had you missed the best
40 single days of market performance for that same period, you would
have lost $18,540—a difference of over half a million dollars! This is the
Achilles’ heel of market timers as returns are often concentrated in very
short time frames.
This impact was particularly profound during and after the financial
crisis of 2008. Many investors who panicked and got out of the market
remained risk averse. They missed large gains that followed in 2009
and beyond, and some have still not been able to regain their
pre-crash capital.
So how do you avoid cognitive biases affecting your investment
decisions? Work with a financial advisor to create a long term financial
plan that is right for you... and then stick to it. Market conditions alone
should not be a trigger to change your asset allocation.
Investment maven Warren Buffet once said: “If you are not willing to own
a stock for 10 years, do not even think about owning it for 10 minutes.”
He was talking about individual stocks, but the same can be said for
the entire equity market. So the next time we see a sharp decline—and
we will—just remember that the most effective way to build wealth is
not by timing the market, but by time in the market.
a
CDSPIprovidestheCanadianDentists’InsuranceProgramand
theCanadianDentists’InvestmentProgramasmemberbenefitsofCDA
andotherparticipatingprovincialandterritorialdentalassociations
.
600,000
500,000
400,000
300,000
200,000
100,000
Fully
Invested
Missed 10
Best Days
Missed 20
Best Days
Missed 30
Best Days
Missed 40
Best Days
J.P. Morgan Guide to Retirement™ Presentation (2014)
Staying Invested is the Key to Success
Returns of S&P 500: 1993-2013
+$191,110
(5.49% ret.)
+$483,320
(9.22% ret.)
+$81,400
(3.02% ret.)
+$19,840
(0.91% ret.)
-$18,540
(-1.02% ret.)
Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.
15,500
15,000
14,500
14,000
13,500
PRICE
TSX/S&P Composite Index
One year ending December 31, 2014
Fig. 1:
Volatility of the TSX/S&P composite index in 2014.
Fig. 2:
Returns of the S&P 500 for the 1993–2013 period