It was the summer of 1985, and I had just graduated from high school. My Dad and I were headed to Cedar Point. We hadn’t been in years and this would be our last father daughter outing before I headed off to college. I couldn’t wait! I bragged to my friends that the first thing that were going to do is ride the roller coaster, Gemini.
Upon arriving, we made a mad dash for the park map and plotted our course. We walked swiftly and dodged a few Berenstain Bears, sidestepped the Happy Hobo Band and evaded the Keystone Kops. We could see the peak of her steel and wood structure and we moved swiftly. As we approached, we could see the line and from where we stood it said that our wait would be approximately 45 minutes. We waited anxiously and after almost exactly 45 minutes, we were boarding. The ride began with a slow click-click-click as it approached the BIG drop. If you have ever ridden on a roller coaster, you know what I mean. It’s the type of drop where you can’t see the track in front of you and you feel like you are going to come out of your seat. For me, the anticipation is the worst. Feeling panicked, I turned to my Dad and said, “I don’t want to do this anymore, why did you make me do this?” and a few more choice words that I had never said in front my Dad before. My stomach was churning and I wanted to cry. We slowly climbed to the top and I swear the ride stopped and was torturing me. My Dad turned to me and said “I didn’t even want to do this, this was your idea.” And then before I could say anything, we were plummeting, twisting, turning, rising and falling.
We exited the ride and my Dad turned to me with a look on his face that, unfortunately, I had seen a few times before. He wasn’t happy. But I was ecstatic and ready to get back in line and do it all over again! How quickly I forgot how much I hate that slow climb to the top and agonizing drop.
Investors in 2020 have certainly felt like they were on a “grip the handle bars” type of amusement park ride. The S&P 500 has experienced a roller coaster of returns with two of its top 10 daily market gains of over 9% in March, and in between those two gains, we saw the third ever worst daily drop of almost 12%. In fact, 18 of the top 20 largest intraday point swings since 1967 were also experienced this year. It was only natural that emotions ran high as we experienced the many peaks and valleys, twists and turns, that led up to March 23rd and the subsequent recovery.
We talk a great deal about behavioral finance and recent events have brought light to the fact that investors are not always rational and are often influenced by their biases. Behavioral finance tells us that most individual investors without a written plan routinely make decisions based on emotion and often fall prey to their own inherent biases. The field of behavioral finance has become popular and well researched with six Nobel prizes having been awarded for behavioral research and economics. Not even three short years ago, I spoke about this same topic. But times were much different back in 2017. In fact, I quote myself as having said “many investors have been lulled into complacency about stock market volatility.” Goodness, how times have changed!
One of the ways that behavioral finance affects investors is through a tendency referred to as loss aversion. Loss aversion studies have shown that the pain of losing money in the market is twice as agonizing as the joy of making money. The investor who falls prey to loss aversion will go to such extremes as to sell out of equities to avoid a potential loss. Imagine if you had sold all your equities and gone to cash on March 23rd and missed out on a 50% recovery! Investors that are unaware of their loss aversion bias tend to gauge gains and losses on different scales. Studies reveal that unless we think critically about our financial choices, we will try twice as hard to dodge a loss than we will to achieve a comparable gain.
Fortunately, most of our clients remained invested in equities through the volatility that we experienced earlier this year. Although we know that it is a bad idea, our brain screams at us to “get out!” before we plunge to the bottom. You can think of it as jumping out of the car as the roller coaster is making its quick descent down. Nothing good can come of this. When investors let biases take the wheel, they tend to sell out of the market at inopportune times and buy back into the markets at the wrong time. By staying invested and disciplined, rebalancing back to target equity weights, you participated fully in this amazing market recovery and made it safely back to the gate. Missing the first month of a recovery can often be as devastating from a long-term wealth perspective as enduring the first month of the bear market decline. Helping our clients avoid making costly emotional decisions adds significant long-term value to their portfolios.
So how does one avoid the traps of behavioral biases? We believe that the best strategy is to design a portfolio that meets your long-term goals that is suitable for your risk tolerance. Whether you are high risk, 100% equity, roller coaster fanatic and can stomach the volatility with your hands in the air. Or maybe you prefer a more balanced portfolio and the giant Ferris wheel, you go up and you go down, but its steadier and certainly less volatile, but still provides growth and enjoyment. Regardless of the type of investor you are, having a written plan and sticking to that plan will be key to achieving your goals.
While our day at Cedar Point did not involve a second ride on the Gemini, we certainly had a wonderful time. We traveled the Frontier Trail, got our pictures taken in pioneer garb, and enjoyed the views of Lake Erie on the giant Ferris wheel. The moral of the story is that if you do venture on to a roller coaster, be sure and find one that suits your needs and be prepared for twists and turns, highs and lows. But once you have made sure that you are on the right ride for you, sit back and try to enjoy the experience. And above all else, please remain seated!