“A genius is the man who can do the average thing when everyone else around him is losing his mind.” – Napoleon
Solution to Minimizing Future Regret: Asset Allocation
Market prices continue to be volatile. Every day seems like a big news day. Every day seems to have big price movements. Because of the volatility, investors are asking these types of questions:
- Have prices hit their low point?
- Are prices going to fall further?
- If they bounce back up, how fast and how high?
- If they fall, how fast and how low?
Many questions with few exact answers. Only in hindsight can people be certain. As we have said in the past, you will not know the top or bottom until many months later. However, that does not stop everyone from trying to guess. This happens even with study after study telling people that guessing is a futile endeavor. Why? We are human beings with emotions and feelings who interact with other human beings who we think have it figured out.
We all have experienced this in some way. My family member, my co-worker, my friend, or my neighbor knew what was going to happen. It is not that it can’t be true. From a probability standpoint, someone is bound to be on the “correct” side. Yes, someone sold on January 3rd of this year. However, here comes the catch. When did they buy? When are they going to go back in? The same questions posed above never go away. There is no bell at the top. There is no bell at the bottom.
If we can accept that continuous market timing is a difficult game to play, then we can move on to other possible solutions. One such solution is asset allocation targets. We could spend countless pages discussing the intricacies of this solution. In fact, many people have. For all the complexities, its biggest benefit is creating simple action steps while keeping investors away from their emotions and forecasts.
Let’s take a hypothetical investor with 50% in stocks and 50% in bonds. Assume stock prices decline by 30%. To keep the 50/50 split, this investor needs to buy stocks and sell bonds. This could have been 5-10% of the portfolio that needed to go from bonds to stocks. The remaining 90-95% of the portfolio remained untouched. Assuming stock prices return to original level, this same investor most likely would sell that same 5-10% of the portfolio to get back to 50/50. Buy low, sell high.
Reading that paragraph seems easy enough. However, not so easy if people remember what March 2020 felt like:
“Buy stocks? They keep falling. Why would I do that? I’ll just wait until things settle down and people get back to normal lives.”
The same could be said for selling stocks at the end of 2020 or in 2021:
“Sell stocks? People are making so much money in the markets. Why would I do that? I wish I could have more of those high return investments people keep talking about”
The asset allocation targets are not meant to catch the exact bottoms or the exact tops. Will you sell everything at the top? No. Will you buy everything at the bottom? No. Will you do a little bit of both? Yes. Maybe more importantly, will you avoid doing the reverse at each of these points? Yes. The simple things can add up over time and help reduce regret along the way.
At this point, we should talk about new investment money. Easier to see how investors with a long previous record might respond to these events to manage existing portfolio allocation. However, new cash investments carry an extra burden. Unfortunately, there is no easy answer.. Experience shows us that some form of regret will always play a role. Within that statement also lies the answer though. It is unavoidable. Knowing that can help take the self-enforced pressure off ourselves. No one will ever get it exactly right all the time.
Investors also must remember their “why”. Day traders need to win now. Long-term investors need to win over longer time periods. Keeping score everyday can be helpful for some investors. However, when keeping score, just remember what game you are playing. A correct score is not helpful if it is for the wrong game.
Asset allocation targets have a fundamental purpose no matter where you are in the investment lifecycle. They are the lighthouse in stormy weather that we keep returning to. They are the object we focus on to mitigate the feeling of regret. This does not mean that allocation targets should never change. However, trying to find a new lighthouse in the middle of the storm is hard enough. No need to make that even harder than it already is. Remaining calm sounds simple, but it is not easy.
With Memorial Day weekend upon us, we do our best to remember those that have died serving our country. Unfortunately, the daily violence continues and men and women continue to put themselves in harm’s way to protect the many. With that said, hopefully everyone can enjoy some friendship or family time this weekend. The unofficial start to summer as arrived.
Thanks for your continued trust and please do not hesitate to reach out to us with any questions or concerns.