Outside-IN

Reset your thinking for 2019

Stocks are forward-looking; investors should be, too

Feb 26, 2019 @ 2:34 pm

By Damian Ornani

2018 challenged many clients with a rockier road than 2017—and disappointing returns to boot. One recent study showed 90% of major asset classes posted declines through mid-November, with cash outperforming stocks and bonds. That preceded December's swoon.

Now many think 2019 will be similarly bleak, extrapolating past returns forward. In my view, this mindset puts clients' financial health in peril. Yesterday's market movement doesn't predict today's or tomorrow's. One of investing's greatest challenges is to think like markets — assessing the future uninfluenced by recent angst.

The recent past often clouds folks' minds, causing them to eye the future through the lens of what just happened. Psychologists call this recency bias. It is also a risk.

Letting emotions sink or swim with the markets can lead to reactionary decisions — dumping what hurt and chasing what held up better: essentially, seeking safety after markets fell. If mutual fund flows are any indication, many retail investors sold after stocks fell in the fourth quarter.

If markets were serially correlated — meaning past movements impacted future — then this wouldn't be problematic. The trouble is, that doesn't apply in the markets. 2017's smooth ride to stellar returns didn't predict 2018. Heck, markets hovered near record highs in September. That positivity didn't predict.

Recency bias raises the risk of repeat client disappointment: missing rebounds after dips; perpetually chasing better returns; sitting sidelined, uncertain about how to put retirement savings on a viable track.

(More: Millennials turning to automated investing in response to market volatility)

While the past isn't predictive, history is instructive. From a bird's-eye view, it shows how recency bias trips up many clients — and how to overcome it. Similar bouts of volatility erupted in 2011 and 2015, coinciding with meager annual returns. Stocks resurged thereafter. Going further back, there have been 26 distinct periods since 1925 when cash outperformed stocks and bonds on a trailing 12-month basis. Following 18 of those periods, stocks rose over the next 12 months. So in all year-long periods when cash was "king," stocks subsequently dethroned it nearly 70% of the time.

If your clients presume that worse times lie ahead because 2018 disappointed, ask them to share forward-looking reasons they expect continued poor returns. Then ask if this actually constitutes new news. If not, here's a third question: To what extent do stocks already reflect this information? If the fear has been in the media a bunch, stocks probably reflect it to a very large extent, sapping its power.

Clients often struggle to shake jarring events, but markets don't dwell. Acting on the past — when markets have moved on — isn't a great way to invest going forward. To keep the past from carrying clients away from their financial goals, help them look ahead, no matter how compelling the rear view.

(More: Communicating with clients in tough times)

Damian Ornani is CEO of Fisher Investments.

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