Stock market discussion: discipline is the best weapon against a bear

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“Stock prices have reached what looks like a permanent high plateau.” – Legendary economist Irving Fisher, October 16, 1929

“Wall Street lays an egg.” – Variety title, October 30, 1929, following the Black Tuesday crash that sparked the Great Depression

With all the technology, education, experience and resources at their disposal, why are market forecasters so often wrong? Retirement investors would clearly like to act on accurate predictions to adjust their portfolios ahead of a big downturn or major rally, but history proves that’s a wild ride. For example, Wall Street firms’ predictions of market direction are about 70% accurate. Coincidentally, the stock market goes up 70% of the time, so a broken compass pointing north would do just as well. And studies consistently show that specific 1-year return predictions are about as accurate as throwing darts at the Wall Street Journal.

Given the inability to predict market fluctuations with any degree of certainty, what steps should long-term investors take to deal with the inherent volatility? The best and most effective strategy is to have a plan that considers inevitable cycles and imposes the discipline to stick to the plan.

“The Federal Reserve does not currently forecast a recession.” – Ben Bernanke, Chairman of the Federal Reserve, January 10, 2008

Recessions are an inevitable part of the business cycle and have occurred 13 times since the end of World War II. Few if any of them have been accurately predicted by consensus forecasters, at least with enough time to provide actionable insights for investors. President Bernanke, who had hundreds of doctors at his disposal. Fed economists, assured Congress that any impact from subprime mortgages would be “contained.” In fact, the worst economic crisis since the Great Depression had already begun the month before his comments.

To complicate matters further, stock market cycles do not directly coincide with the economic cycles that typically drive them. Market peaks typically occur 6-8 months before peak industrial production and market troughs lead to economic recoveries lasting 4 months on average. Since professionals have little success in avoiding downturns, average investors must accept and even embrace cyclical volatility. Remember that downside risk in a well-diversified portfolio is precisely why stocks offer superior returns over time.

“It’s not what you don’t know that gets you in trouble. It’s what you know for sure that just isn’t the case.” – Attributed to Mark Twain

Whether uttered by the renowned comedian or not, this quote succinctly encapsulates the psychological barriers to maintaining portfolio discipline.

Investors, being human, react to several psychological factors in making difficult but essential decisions to overcome for long-term success. One of these psychological biases is overconfidence: overestimating one’s understanding of the market or one’s ability to predict outcomes or failing to recognize what one really does not know. For example, surveys consistently show that over 70% of adults think they are above average drivers.

Another common obstacle is called recency bias, the tendency to focus more intensely on recent events and ignore the bigger picture. This can lead investors to assume that a current bull market or selloff will continue in the future and can lead to reactionary moves against the overall plan. And many people possess an inherent loss aversion that makes them fear losses more than they enjoy equivalent gains.

These and other behavioral responses are hardwired into our brains by instinct and, in many cases, are modern manifestations of the primitive “fight or flight” response. The combination of an inability to predict the future with a psychological instinct for overcorrection can seriously hamper investment returns.

According to research firm Dalbar, over the past 30 years, passive investing in the S&P 500 has earned 10.6% annually, while the typical real-world equity fund investor has earned just 7. 1%. On an initial investment of $100,000, the average individual would have left over $1.2 million on the table trying to time the market.

“By about 2005, it will become clear that the Internet’s impact on the economy has been no greater than that of the fax machine.” – Nobel Prize-winning economist Paul Krugman, 1998

If we can’t predict the market accurately, and if our own biases are getting in the way anyway, the best solution is the tried-and-true approach of creating a long-term plan when things are calm, then keeping the follower at bay. stick to the plan when the going gets tough. Too many retired investors panicked in March 2020 and sold when the market had fallen 25%, only to sit on the sidelines and watch the rapid market recovery overtake them. Instead, investors who stuck to their game plan took the opportunity to rebalance portfolios toward goal and reaped outsized rewards during the rapid recovery. And they slept better.

“It’s hard to make predictions, especially about the future” – Yogi Berra

Until humans develop a much more accurate ability to predict economic and market fluctuations, market timing will inevitably fail. Behavior is a much more important determinant of returns than fund performance.

Christopher A. Hopkins is a Chartered Financial Analyst and co-founder of Apogee Wealth Partners

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