Armchair Quarterback- Looking Back to the Bottom
Monday, May 3rd, 2010 by Charles Mayfield, CFP®
This week, I received a performance piece in the mail from one of the money managers we use with our clients. Its focus was on dealing with investor behavior and the emotions we assign to our money. If you have been reading our blog for a while, you know what’s coming. Our behaviors and emotions can wreak havoc on our investments, sometimes leading to severe mistakes when it comes to decisions about how our money is invested. But I assure you, taking the emotion out of your investment decisions can save you a lot of…well…heartache.
Now that we have some time to look back, I thought it relevant to apply some of the behavioral principals to what we have seen in the preceding 13 months. For my research, I looked at the S&P 500 Index (net of dividends and stock splits). The market low was March 9th, 2009. On that day, the S&P closed at 676.53. In the days leading up to this low, it had gradually spiraled down to this point. As we look at the days/weeks that followed this point, I want you to keep in mind some of the “behavioral” thoughts we assign to investments. Cass touched on several of these in his blog post from November of last year.
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March 9, 2009: S&P closes at 676.53- the market low
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March 16, 2009: S&P closes at 753.89- up 11.43% a week later
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March 23, 2009: S&P closes at 822.92- up 21.64% two weeks later
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March 30, 2009: S&P closes at 787.53- up 16.41% three weeks later
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April 6, 2009: S&P closes at 835.48- up 23.49% four weeks later
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April 9, 2009 (1 month from the low): S&P closes at 856.56- up 26.61% one month later
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April 21, 2010 (I’m writing this on the 22nd): S&P closes at 1205.94- up 78.25%
Disclaimer: Past performance is no guarantee of future results. The market for all securities is subject to fluctuation such that upon sale an investor may lose principal.
What am I trying to illustrate from this exercise? We have a real world example of how investor behavior can really take a chunk out of your long term growth. I’ll focus on two distinct behaviors:
1- Representativeness: Where an investor labels an investment as “good” or “bad” using recent performance. It is easy to see how someone could have done just that with the S&P in March 2009. The probability of “sidelining” your money based on the previous decline could be very high.
2- Snake-bite Effect: Investors forego strong growth opportunities, regardless of whether or not the circumstances are different, if they were “bitten” before. You can’t argue with the “opportunities” posed by a historic low in the S&P. With the Y2K/Tech bubble bursting still pretty vivid in the minds of many investors, it’s easy to see how confidence may have been overcome by fear. In the face of the decision to stay invested, the traditional investor would have likely stayed out of the market.
Let’s assume for a moment that you were “out” of the market already on March 9th, 2009. When does one decide to get back in? Well, usually the decision to start investing again comes with a price. In this case, the price of waiting would be pretty steep. We already know that if you were invested from the low up through close on April 21st, 2010 you were rewarded with a 78.25% return. What would that look like if you waited until your “confidence” in the market was restored (compare to 78.25% return for those who stayed in the market):
- Waiting 1 week – return: 59.96%
- Waiting 2 weeks- return: 46.54%
- Waiting 3 weeks- return: 53.13%
- Waiting 4 weeks- return: 44.34%
- Waiting 1 month- return: 40.79%
Observe that an investor who waited a month to get back in ended up with only a little more than half the investor who remained committed to the market.
Of course hindsight is 20/20. It’s easy it is to look back on the last 13 months and tell yourself that you would have jumped in on March 9th, 2009; but did you? Waiting just 1 month to “get back in the market” would have cost you a whopping 37.46% return on your money. Given the slight downturn in the market the week of March 30th, 2009 it’s easy to see how an investor might have justified waiting just a bit longer. Taking the emotion out of investing is one of the hardest lessons for most investors to learn—but is often times the most valuable.
