We are
THE BLUE MONEY REPORT.
If you are interested in providing your readers with our syndicated column, you can request it here
The Blue Money Report
"History suggests that capitalism is a necessary condition for political freedom. Clearly it is not a sufficient condition."
~ Milton Friedman
Welcome to the Blue Money Report
Today's Commentary: 08.16.02 In the course of conversation with an aquaintance of mine, Larry Swedroe, he decided to quote himself and sent me the following article. Was it possible to pay too close attention to how well you were doing, or better yet, how poorly?
Frequent Monitoring of Your Portfolio Can Be Injurious to Your Financial Health
Behavioral finance has provided us with many valuable insights into how human behavior can impact investment results. As one example, we have learned that individuals are highly risk averseon average odds of 2:1 or greater are required to entice them to accept an even money (50:50) bet. Another related example is that investors feel the pain of losses much more than they enjoy the good feelings generated by equivalent profits. By studying human behavior patterns we can learn how to avoid mistakes that we seem almost programmed to make.
When we look at the historical record of investment returns, we find that the vast majority of long-term returns are derived from just seven percent of all trading months. The returns of the remaining ninety-three percent of the months on average is virtually zero.* The result is that the shorter our investment horizon, the more likely it is that investors will experience a loss in the value of their portfolio. At a horizon of one day the odds of experiencing a loss are about 50:50. The odds don’t improve much if we extend the horizon to a month. Even at one year the odds of seeing the value of an equity portfolio shrink are about thirty percent. However, if we extend the horizon to ten years, there have been only two periods of ten or more years since 1926 with nominal declines in value (1929 thru 1942 and 1930 thru 1942).
Let us examine how the length of the investment horizon can impact investment results. Behavioralists have noted a tendency for investors to experience what is called myopic loss aversion. The concept of loss aversion, first introduced by Daniel Kahneman and Amos Tversky in 1979, ** refers to the aforementioned tendency for investors to weigh losses more heavily than gains. Myopia refers to a narrowing of the viewfocusing on the most recent, short-term results, even when the investment horizon is long.*** Given the random nature of short-term investment results, investors that check the performance of their portfolios on a daily basis will experience many days of losses. Conversely, the longer the time frame between evaluations the less likely it is that the portfolio will experience losses. Given that investors feel the pain of losses far greater than they feel the joy of gains, they are likely to not only experience disappointment if they check their portfolios with great frequency, but they are more likely to panic and sell, as the pain of losses becomes intolerable.
Behavioralists have used myopic loss aversion as one possible explanation for the answer to what is known in academic circles as the "equity risk premium puzzle." The puzzle is why the equity risk premium has been so large when there have been very few long periods of poor equity performance. The behavioral solution to the puzzle is that the pain of short-term losses is so great that investors demand a large risk premium in order to compensate for the pain they endure in the short term.**** Of course, another solution is a risk related one: equities are very risky and the large risk premium reflects that risk. The large return to investors simply reflects what has been called "the triumph of the optimists" the risk of equities simply has not shown up in the U.S. over the long term. There is of course no guarantee that it will not show up in the future.
How can myopic loss aversion impact investment results? Investors that check on the values of their portfolio with great frequency are more likely to be subject to this “disease.” And with the advent of the Internet age, most investors now have the capability to check on their portfolio’s valuation on a daily basis with great easeunfortunately subjecting themselves to the pain of losses with great frequency. This pain, caused by myopic loss aversion, can easily cause them to stray from a well-thought-out investment plan (asset allocation). This is especially true in bear markets when the frequency and intensity of the pain is greatest. Thus investors become susceptible to that dreaded condition known as convex investingbuying high and selling low.
The obvious conclusion that one can draw is that the less frequently individuals observe the performance of their portfolios, the more disciplined, and more successful, they are likely to be as investors. Unfortunately, the Internet age tempts investors with tools that make checking valuations far too easy a task. Investors are best served by going on a "portfolio valuation diet" long periods of fasting, and the longer the better, with a very occasional stop at the dessert tray. The longer the fast, the more likely it is that the dessert will be sweet.
For those interesting in learning more about how human behavior leads to investment mistakes, the first section of my book Rational Investing in Irrational Times, "Understanding and Controlling Human Behavior Is an Important Determinant of Investment Performance," covers thirteen behavioral mistakes investors make. The book provides both the diagnosis and the prescription for the cure. The book also covers another forty-nine investment mistakes even smart people make.
* Sanford Bernstein.
Larry Swedroe is the author of "What Wall Street Doesn’t Want You to Know," "The Only Guide To A Winning Investment Strategy You Will Ever Need," and "Rational Investing In Irrational Times, How to Avoid the Costly Mistakes Even Smart People Make Today," was published in June by St. Martins Press. Larry is also the Director of Research for and a Principal of both Buckingham Asset Management, Inc. and BAM Advisor Services in St. Louis, Missouri. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services.
Today's Commentary: 08.13.02 I want to say what everyone wants to hear. I want to say it loudly enough so that those beneath their desks in the fetal position can hear every word. So what should I say? Should I say what Mr. Greenspan said today? Or what Mr. Bush said?
The Federal Reserve Board met today in Washington and reported to the country that things are not as good as they could be. They left interest rates in tact for yet another session, sustaining the 40 year low a little longer. Wall Street reacted as expected, selling off sharply in what has become a common occurrence. You can almost expect the buying frenzy as individual investors, which means that very few institutional ones are involved to any real degree, will be busy in the market tomorrow.
Did the market want to hear that rates could go lower? Should they have dropped another 25 basis points? 50 maybe? Perhaps they should just take it to zero and see whether anyone can be happy. There is increasing anxiety among lenders as well as borrowers that no matter what the rate, no one is going to bother to take the bait.
Meanwhile, down in Texas, the President held his economic rally with a group of his closest (financial) supporters which included some very big names in business and excluded anyone that looked like a Senator. These big name attendees share the same concern over the economy that the President has. If things aren't getting better, the wind of change will blow in a direction that will not favor the current administration.
Optimistic is something that the President tries to be. Concerned is also a nice trait. But neither will solve the problems facing the economy in the short term. There is little being done to persuade America that investing in anything is a good idea. And that is the most catastrophic problem facing every business today.
If the very people who find themselves at the heart of economic recovery can't agree on what they see, can we expect the economy to find a central force to attach its hopes and dreams.
Deep down, we all know that most CEOs are honest business people. We know that some, no matter how much they swear or what oath they pledge, will still break the law. But are we willing to believe that any attempt at making money in the markets will produce anything close to a positive return. The current business environment is not so good. Does anybody really expect us to believe otherwise?
Layoffs will continue. Wage freezers will replace those healthy gains of the past several years. Paychecks, already becoming lighter with smaller bonuses and much less overtime, will be faced with increased out of pocket costs as health benefits and insurance are force fed on the worker. This could be a byproduct of poor corporate management. Maybe not. But that isn't how the average earner will see it.
The worker will in return be either forced to give up benefits as a result or lose any wage bargaining position. Increases in the cost of benefits that employes are paying to maintain health benefits have increased to 15% in most cases. If wages were to increase at the same pace, they would need to quadruple to make it even. These folks are at the backbone of any recovery and the continued negative pressure facing them is growing every day.
Tight labor markets increase wages disproportionately. Companies were forced in the heyday of the nineties to keep salaries and raises competitive. When the market swells with available workers, the need to increase salaries at a non management level loses its luster. Despite the numbers that are currently out there concerning paychecks.
There will be growing concern in how these numbers are portrayed, as they drift farther from reality. Some of the numbers trotted out by the Bureau of Economic Analysis contain all sorts of inclusions. The average worker's pay increases are a result of factors such as what contribution the employer makes on your behalf, such as pension contributions and health benefits.
Health benefits contue to rise in the face of these numbers. Many corporations are groaning at the costs of insuring their employees which are reported to be rising at a rate of 6.9%. This is well above most wage increases of 3.5%. This political hot potato will be tossed back and forth around the beltway as neither party wants to take control of the issue. The memory of the Bill Clinton's failure in the early nineties is still fresh in many elected minds.
The disconnect between politicians looking for a solution to these problems will grow into a disconnect among voters. The real question is in the hands of those folks who vote. Can we live with a plan that will take much of the demand care from the plan, the perks that everyone wants, in exchange for the type of care that many managed plans offer?
Keeping the children insured through federal and state insurance programs is a must. Keeping their parents insured as the try to determine whether they can afford premium increases, that in some instances are growing at 20% every five years or so, is a much more difficult task.
Mr. Bush should look at the consumer and their ability to continue to spend as the real loss of confidence. No tax incentive to increase investments in retirement will do any good if those potential investment dollars are going towards insurance premiums. The growing deficit, once the nest egg for just this sort of rainy day, is gone. And with it, the confidence that no matter what happens, the average American will be protected.
There is where the real disconnect occurs.
COLUMN REQUEST
| ARCHIVE
|
WHO WE ARE
| CONTACT US | LEARNING
CENTER |