Here’s how best to play the market for the rest of 2022: Don’t look.
I offer this advice not because I believe the bear market will continue—though of course it could. I would offer the same advice if I thought the next leg of the bull market is about to begin.
The reason not to look is that “looking” is not a benign act. It actually changes your behavior—often in destructive ways.
I was prompted to make this observation by a fascinating recent study that began circulating in academic circles. The study, “Unpacking the Rise in Alternatives,” was conducted by Stanford’s Juliane Begenau and Pauline Liang and Emil Siriwardane of Harvard. This study focuses on a relatively obscure feature of the investment industry—the large increase over the last two decades in the average pension fund’s allocation to so-called alternative investments such as hedge funds and private equity. But what the researchers found has implications for all of us.
By applying a series of complex statistical tests, they concluded that a major determinant of a given pension fund’s decision to establish an allocation to alternative investments was whether other pension funds in the same geographical region were doing so themselves. In other words, if a pension fund in a given region initiated a major allocation to alternative investments, then odds increased that others close by would do so as well.
Good ol’ peer pressure, in other words. So much for the independent analysis supposedly conducted by the high-priced analysts and consultants employed by pension funds.
The reason this is relevant to all of us: If these investment experts are unable to think independently, it’s even less likely that any of us will be able to do so. And that can be costly. To be contrarian, for example, to mention just one well-regarded strategy, requires us to go against the consensus. To the extent we’re constantly looking over our shoulders to see what others are doing, then being a true contrarian becomes even more difficult than it is already.
I’m reminded of the classic observation from the late British economist and philosopher John Maynard Keynes: We would rather “fail conventionally than… succeed unconventionally.”
Myopic loss aversion
Peer pressure is just one of the reasons that we should reduce the frequency with which we focus on the markets’ short-term gyrations and how our portfolios are faring. Another major one is known as Myopic Loss Aversion (MLA).
MLA exists for two reasons. First, we hate losses more than we love gains, and it’s hard to resist checking how our portfolios are performing. As a consequence, when we more frequently check our portfolio’s net worth we will have higher subjective perceptions of risk. That in turn translates into a lower allocation to riskier investments—the very ones that typically produce greater long-term returns.
The discovery of MLA traces to research in the early 1990s by Shlomo Benartzi, a professor and chair of the Behavioral Decision-Making Group at the UCLA Anderson School of Management, and Richard Thaler, Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business (and 2015 Nobel laureate in economics). Since then the existence of MLA has been confirmed by numerous studies.
One of the most telling compared the performance of professional traders in two different groups: Those who focused on their portfolio’s performance on a second-by-second basis and those who checked every four hours. Those in the latter group “invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information,” the study found.
I doubt that any of you are checking your portfolio status every second of the trading day, though I know that some of you come close to doing so. But the study makes clear the general pattern.
To use an example more relevant to the typical retail investor, imagine Rip van Winkle falling asleep at the beginning of last year, 18 months ago, checking the S&P 500’s
level right before he dozed off. If he were to wake up today and check the market, he’d probably yawn and fall asleep again. On a price-only basis the S&P 500 has gained 1.1% since the beginning of last year, and 3.3% on a total return basis.
In contrast, if Rip Van Winkle woke up every month and checked his portfolio, he’d now have motion sickness. The S&P 500 produced a 5.9% total return in its best month since the beginning of 2021, and lost 9.0% in its worst month.
My Rip Van Winkle illustration isn’t as hypothetical as you might otherwise think. In 2010, Israel implemented a regulatory change that prohibited mutual-fund companies from reporting returns over any period shorter than 12 months. Prior to that change, one-month returns were prominently reported in client statements. A 2017 study conducted by Maya Shaton, an economist in the Banking and Financial Analysis section of the Federal Reserve, found that the regulatory change “caused reduction in fund flow sensitivity to past returns, decline in trade volume, and increased asset allocation to riskier funds.”
“Not looking” may be unrealistic…
Averting your eyes from the market and your brokerage statement may be asking too much, however, especially given the markets’ recent extraordinary volatility and the near saturation coverage of that volatility in the financial press. If that is true for you, then you need to determine how to stay disciplined in adhering to your preset financial plan while nevertheless following the markets’ short-term gyrations.
What that looks like in your particular situation will depend on your personality. It might require handing day-to-day control over your portfolio to an investment adviser who is instructed to never deviate from your predetermined financial plan. Another possibility would be to invest only in mutual funds that restrict how often you can trade. Yet another would be to work with your brokerage firm, IRA or 401(k) sponsor, or adviser to both reduce the frequency with which they report your performance and to increase the length of the periods over which they do report performance.
As you think about what would be required, it’s helpful to remember what Ulysses of Greek myth did in order to be able to listen to the Sirens’ beautiful singing. He knew that he would be unable to resist their alluring songs, and yet he also knew that succumbing to that temptation would be fatal. So he had his men tie him to the mast of the ship on which he was sailing so that he could listen. Our job is to figure out the modern-day equivalent of tying ourselves to the mast.