When Knowing What Will Happen Isn’t Enough
By Roger Nusbaum, AdvisorShares ETF Strategist
The Barron’s cover story this week was about the extent to which artificial intelligence (AI) is making its way into more aspects of life and technology including the financial services industry. Andrew Lo from MIT had an interesting quote in there related to investor behavior;
“We can tell people all day long that the market will come back, but that’s like trying to prevent teenage pregnancy by preaching abstinence. It’s not realistic because it doesn’t account for human nature,”
This is of course a conversation we have here all the time in these posts. In a similar vein, Cullen Roche quoting Bill Bernstein;
“…a suboptimal strategy that you can execute is better than an optimal strategy you can’t execute.”
These are both (related) crucial building blocks of understanding for managing money and working with clients. To Lo’s belief that it is futile to tell clients that markets will come back; an advisor will have more credibility on this front if they get out in front of the next bear market, reminding clients that cycles have not been repealed and they should expect a large decline and then after that large decline…the market will come back. Human nature, as Lo puts it, is to forget what large declines feel like which leads them to believe that “this time is different.” Waiting until the market is down some large number before saying “it will come back” probably is futile.
This is where the Bernstein quote comes in to play. Cullen’s post talks about bonds’ role for helping temper volatility. One role of an advisor is devising a suitable asset allocation for each client using their philosophy/strategy in a manner that makes sense for every aspect of the client’s particulars. The assumption here is that the client bought into the philosophy/strategy upon hiring the advisor.
I write a lot of posts that explore various allocation strategies, the use of alternatives, the use of tactical strategies and other methods that offer the opportunity to manage volatility. We’ve all read plenty of commentaries about behaviors being the biggest impediment to investment success. Usually this boils down to panicking at a low or being greedy at a high.
Throughout the entire Bitcoin arc (for the last seven or eight months anyway) I’ve very consistently said that if you have to speculate on it (and that is what you’re doing at this point) then you should go very small like maybe 1-2%. The idea was that if the six figure price targets turn out to be correct, then a 1-2% allocation can grow into a life-changing piece of money but if it goes poof it was merely a bad trade.
As I write this post on Monday afternoon Bitcoin is just under $6800. At that figure Yahoo Finance has it down 60% from its early January high. Obviously, people were buying at/near the highs. How many of those folks are looking back at merely a bad trade and how many have been crushed by over allocating to something that is down 60%? The answer is not knowable of course but the behavior is something that repeats over and over.
That is the greed side of the ledger, but the fear side may be just as destructive. We know people sold at the market lows nine years ago, people sell at every low. The damage in that scenario comes from sitting in cash and watching the market race higher.
Right here right now while the market is at worst a little wobbly, take the time to remind clients how markets work, that declines followed by recoveries are historically normal and will likely happen again. This motivates me to find ways to manage portfolio volatility for clients and if you also think that might be a good idea then I would encourage more research on how to do it.
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