We have posted videos and articles about how difficult it is to time the stock market. Indeed, we believe it is a fool’s errand and over a half century of data supports this position. Perhaps you’ve listened to Talking Real Money on the radio or the podcast to hear Tom & Don discuss this topic time and again. For these reasons we will not indulge in the evidence yet again but we will talk about why it’s so very hard to resist attempting to time the market.
Some of you will have heard the term Behavioral Finance. The research behind this term dates back to the early 90’s and comes largely from Amos Tversky and Daniel Kahneman, the latter winning the Nobel Prize in Economics for his work. (The prize is not awarded posthumously as Tversky passed in 1996). Without delving too deeply into the esoteric details of their research, Behavioralism explains why many humans act irrationally, particularly when making financial decisions. Irrational is a word too often used and is a harsh term but when faced with a volatile stock market and a century’s worth of data, we often make the wrong decision to get out of the market.
Stock markets are inherently volatile. But we know that capitalism dictates a positive return on the investor’s dollar or it would fail as an economic system. The evidence is quite obviously to the opposite. And it has been successful for hundreds of years. So why would that end now? Markets can and do go down so the really important decision is how much volatility you can withstand before you’re unable to sleep at night and that’s one of the functions your financial advisor provides; getting your risk exposure, your asset allocation right. But equally important is the function of keeping you in the markets when you’re nervous and thinking of selling due to volatility.
We believe that an educated investor takes appropriate risk and behaves rationally so as to reap the long term rewards of the stock market…of capitalism. Understanding that our behavior is sometimes at odds with the data is an important step in becoming a successful investor.
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