“I have civilized my own subjects; I have conquered other nations; yet I have not been able to civilize or conquer myself.” – Peter the Great
One of the pillars of Pure Portfolios’ culture is you can lose, but don’t lose the lesson. The premise is you can make a mistake, but if you keep making the same mistake, something is amiss.
Here’s a list of six behavioral lessons I learned (or relearned) in 2022. Some are new, some are old.
At the end of each lesson, I’ve included relevant blogs for a deeper dive.
Markets are Human
In a digital world where information is instantly disseminated and available, we can forget that financial markets are humans interacting with other humans.
The origins of economic, business, and market cycles change (COVID, bad loans, etc.), but human reactions to difficult markets are very much predictable. I’m a believer that the study of human behavior and psychology is vastly underrated characteristic of successful investors.
Investor Behavior During the Sell-Off
Forecasting is Really Hard
The Fed wildly miscalculated inflation pressures in 2021. Wall Street market predictions were worse than usual (which is saying something). The biggest and brightest minds in financial markets were caught off guard by pretty much everything.
If an investor was trying to make portfolio adjustments based on the short-term ebbs & flows of the market, it probably didn’t end well.
Tis the Season for Wall Street Forecasting Pt. VI (the average Wall St. S&P 500 forecast missed by over 25% in 2022!)
It Doesn’t Have to Make Sense
You can have a well thought out, rational investment thesis that blows up in your face. It may be tempting to make excuses and blame the Fed, government, or some other external factor. The market doesn’t care that you’re in 100% cash waiting for a correction. The market doesn’t care that you’re levered up in speculative microcap stocks. The market doesn’t care that you’re baffled by its irrational behavior.
The market is always right.
Spotting Inflection Points
Most investors are horrible at spotting inflection points. An inflection point would be the reversal of a market trend. For example, a poor market turning into a good market (or vice versa).
I recently had a prospective client meeting. The gentleman across the table was adamant inflation was rising month over month and would continue to get worse. His emotional narrative was blinding him to what was actually happening (inflation is still elevated, but has been falling for 5+ months).
Be wary of anchoring to an investment identity i.e. “I’m a pessimist, I can’t see how things get better.”
Keep your identity small. It’s okay to change your mind when the facts change.
Calling Market Inflection Points
Build an Investment Framework vs. Making Gut Calls
We all carry personal experiences that shape the way we view money. These biases and blind spots can leak into our investment process.
The last three years making “gut instinct” allocation calls was fraught with danger. Very little in financial markets made sense.
You would laugh at me if I told you the global economy was shut down due to a deadly virus, but the market raced higher by 30+%. That very thing happened in spring 2020.
During that time, our rules-based investment approach signaled to add to equities. It was deeply uncomfortable. I lost weight and wasn’t sleeping stewing over the decision.
We had a similar experience in 2022. Coming off a euphoric 2021 it was tough to lose money, markets quickly pivoted and everything we knew to be true reversed. Leaning into our rules, we reduced equities did our best to mitigate risk during a horrible year.
In both of the above examples, I can tell you with conviction having a investment process to fall back on was huge. I can’t imagine having to make “gut” judgement calls during such a chaotic time.
We use trend and momentum (and other rules), which might not be for everyone. The takeaway is you or your advisor should have a framework for making buy & sell decisions. Random allocation changes based on emotion or short-term market movements is a recipe for disaster.
Why Trend Following Could Make Sense for Retirees
Trend is your Friend, An Alternative to Buy & Hold
Sick of your Advisor Telling you to “Stay the Course”?
The Two Biggest Wealth Destroying Behaviors
The leaders in the clubhouse are performance chasing (FOMO) and avoiding losses.
On the former, I reviewed dozens of prospective client portfolios over the past year. The single biggest issue was a massive overallocation to technology stocks. Many folks piled into the best performing stocks of the last decade, which was great if you were an early investor. Not so much if you invested in 2021.
On the latter, some investors feel they should enjoy the fruits of stock investing (gains), but shun the losses. Investing doesn’t work that way. More wealth is destroyed trying to avoid losses than any other behavioral quirk.
The sequence goes something like this…
“I want to go to cash and wait for things to clear up before getting reinvested.”
“I feel better. Let’s wait for a huge sell-off and get reinvested”
*Market goes down*
“Things are going to get worse. Let’s wait this out.”
*Market goes higher*
“The market is too high. Let’s wait this out.”
*Market goes higher*
“Dang. Let’s get invested.”
Selling is the easy part. Getting reinvested is butchered 99.9% of the time.
I’ve seen the above scenario play out more times than I can count.
Fighting the Market-Timing Urge
Waiting for the All-Clear Investment Signal
You might disagree with my list and that’s fine. It’s culmination of behavioral lessons from a difficult year.
If you’ve made destructive or emotional decisions over the past three years, you might do well to create your own lessons list to avoid future mistakes. You can lose, but don’t lose the lesson.
For more information on how Pure Portfolios strips emotion out of the investment process, hit us up firstname.lastname@example.org.