behavioral finance

View from the Chair: Windermere's Market Perspectives (March 2019)

We all like to think we are fully rational human beings, capable of staying in control of our emotions and making sound decisions in all areas of our lives - especially when it comes to investing. When markets are steady and moving in a upward trajectory, many of us are able to operate in a “calm, cool, and collected” fashion. However, when volatility arises and markets correct, we tend to lose that focus and revert to our subconscious behaviors. (Just think back to your mindset in November and December of 2018 and I’m sure you’ll identify with some reactionary thinking).

While there are countless behavioral finance biases that impact all investors , today we’ll focus on one that has come up in many conversations as of late - anchoring


Anchoring refers to our tendency to attach (or anchor) our thoughts to a reference point - even if that reference point may have no logical relevance to the decision at hand. Here are just a few examples of anchoring - and some suggestions on how to overcome it in and “set sail” from here on out

1.) High-water mark

I’m guessing you may know this number - the all-time high balance you observed for your investment portfolio. Perhaps you arrived at that amount in January 2018 or in early October 2018 or in recent weeks. Regardless of the exact date, you likely know the number and have evaluated your portfolio’s performance against that mark ever since. You may find yourself thinking things such as: “if I could only get back to that value” or “when I get back to that value I’ll (fill in the blank),” or “had I known what was coming, I would have moved to cash when I hit that level”

If you step back, what does that value really represent in your investing journey? Not much - it’s simply a reference point. One of many reference points during a multi-decade journey. Had markets kept advancing past that point would you be focused on that value? Likely not. Would you really have altered your whole investment approach when you reached that number (without any other information)? Again, likely not. Is it logical to compare your performance to that number? Again, no.

That number only has relevance because you have anchored to it. There’s no going back - we are sailing forward and can’t go back. Consider focusing on more relevant comparisons such as the return of your blended investment benchmark over the comparable time period and your unique return goals. How are you doing in comparison to those metrics? Pay attention to relevant data points and you may just pass by that previous anchor

2. Evaluating individual stocks

Anchoring is especially prevalent in evaluating individual stocks, especially when it comes to selling vs holding (or adding to) stocks that have fallen in value. As an example, if we pay $50 for XYZ company and it falls to $30, we become very focused on that $50 price point (we anchor to it). “I’ll sell it when it gets back to $50” or “I’ll just hold on until it gets back to break even - but I’m not buying more” We’ve anchored our assessment of that company’s fair value to the price we paid for the stock, which truly is not all that relevant.

That price you paid is what the market was willing to sell it to you for on that given day. After you buy it, that price isn’t all that relevant any longer. Instead, you should continue to do your homework and independent research and determine what you believe to be the fair value of the company (and its underlying stock). If the stock remains below the fair value by a margin that is more attractive than other alternatives, it may be worth holding - on even adding more. If the stock has exceeded your fair value estimate, perhaps it’s time to move on and find another under-valued opportunity. But to anchor to the price you paid (or even to the current trading price) won’t help you make an informed decision.

Stock markets may be the only marketplace in the world where consumers don’t like to buy as prices come down. However, with the right reference points in your sight-line (ie: your estimates of fair value, independent of price you paid or current trading prices), you will have a shopping list ready to go during the next pullback

3. Market estimates

Anchoring also comes into play in our forecasting of general market performance. Investors tend to anchor on the current level of an index as their reference point and using that, make estimates that tend to be very close to the current level. As the Dow Jones approached 27,000 in early October 2018, estimates were clustered around 28,000 - or even 30,000. And when markets corrected and started to fall, estimates were quickly revised downward, in lockstep with the actual moves in the indexes themselves.

Instead of anchoring to a current index level in determining how to allocate your capital, consider evaluating the current state of the economy and more importantly, the rate and direction of change of those elements. Where do we stand in terms of growth, inflation, interest rates, economic activity, and labor force? And are these components getting better or worse? Those are relevant data points in determining when and how to allocate your capital to various asset classes

Anchoring is an instinctual human behavior - one that we have all been guilty of from time to time. Remaining aware of these examples - and the tactics to pull up your anchors in future - will make you an even better investor going forward.

Let’s sail forward and leave those anchors behind!


Ways to overcome anchoring

*Carefully evaluate your refernece point - is it the rigth metric

*Independent analysis

*Compare to alternatives at the present moment - not the asset in the past

View from the Chair: Windermere's Market Perspectives (April 2018)

What is something worth?  That's a simple question without a simple answer.  You could argue that something is worth the value stated on the price tag, or the price the purchaser is willing to pay and a seller is willing to accept, or even the quantitative price plus an implied value for the associated qualitative benefits.  

Assigning worth (also known as valuation) is not as easy as it seems - especially when it comes to investments.  Let's walk thru a few examples together. 


We'll start with an easy one - cash.  Our bank accounts are worth the balance in the account. Simple, right?  Not so fast.  What about inflation?  Do we need to consider the fact that our dollars may not be able to buy as much when we actually go to spend them?

How about exchange-traded investments, like stocks, mutual funds, and bonds.   Thanks to real-time market news & quotes, after-hours trading, and overseas markets, you can literally value these investments every second of every day by obtaining the current quote for each security.  This is indeed the price a buyer will pay you (a potential seller) for it at that exact instance.  But does that really represent the valuation of your share of the underlying future cash flows of the business or security?   If you still believe in the original investment thesis and future prospects for the underlying entity and intend to remain invested for years to come, does the price at a particular second truly determine the ultimate worth?  Have you incurred a real loss if you choose to stay invested?

What about non-exchange traded investments, like your home?  There's no market quotes for this asset so valuation becomes even more difficult.  Perhaps we decide it's worth what we paid for it, or maybe we elect to apply a bit of a mark-up because our neighbor's house just sold above asking last month.  Or perhaps we decide that its real value is related to the safety and comfort it provides to our family and that since we aren't selling, today's valuation doesn't matter.


You're beginning to see the challenge in assigning worth to investments.  There are many different approaches and variables to consider.  But know this - if you believe the ultimate worth of your investments can be determined in a split second as you refresh your online investment account or track the stock ticker across the scrolling screen, you are mistaken. 

Investing, in our opinion, is meant to be a long-term process, where worth is defined over years, not seconds and where patience and discipline are essential to the ultimate attainment of value.  

So what do you do today? We fully understand today's markets are volatile and that large swings in account values and "shock & awe" headlines in newspapers and TV shows don't lend themselves to a long-term view of worth.  Here are a few things to keep in mind during these times to help you stay the course and focus on the true meaning of value:


1.) Time and temperament are your friends:  Investing is not meant to be a short-term process.  Commit to at least a five-year horizon and know it won't be a linear (despite what 2017 may have led you to believe).  Commit - and then work to remain calm and focused throughout the process.  Trying to time the market and frequently selling out/buying back in is proven to be a losing strategy and counterproductive.  You are an investor, not a speculator.  Focus on what you own and why you own it and how that's likely to translate into value over time


2.) Asset allocation and diversification still matter: You should be working to construct a portfolio that includes a bunch of different investments.  While correlations have increased in recent years and certain stocks have outpaced the average, the below "quilts" help to illustrate how different asset classes (and different countries) perform year to year. 

You can see that a winner in one year can fall to the back of the pack in the next year - and that over time, a diversified mix produces reasonable (and more consistent) returns.  Having a well-diversified portfolio has historically proved its worth and we believe it will continue to do so

3.) Seek useful distraction: Instead of worrying about the latest CNBC newsflash or the daily prices on your holdings, seek a useful distraction.  Remind yourself why you began investing in the first place and.  Study your annualized returns since you first started investing.  Recast your retirement scenarios and see if your returns allow you to reach your goals.  That is time far better spent



4.) It's all about balance:  Good news isn't as exciting to report, and as a result, it gets far less attention.  Recent headlines are swamped with news of possibles tariffs and trade wars, white house administration changes, interest rate policy, and Facebook fallout.  Of course, much of this is true and worthy of analysis - but some of it is hype. 

It's important to remember the "good" and balance that against the risks.  Where's the good?  There's plenty to choose from - including low unemployment, strong corporate earnings and increasing earnings estimates, improving GDP, range-bound interest rates (for now),  and ongoing synchronized global growth.  We are not saying that risks aren't present - they certainly are today and always have been.  However, there is a healthy balance between risk and reward that has, and always will be, a key part of determine the long term worth of investments.  So go ahead and analyze risk - but be sure to analyze the good alongside it

Investing is not easy but in our opinion, it is always worth it. Stay the course and we look forward to hearing about the value you are able to accrue.

Invest on,