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Posted by Craig Basinger on Feb 27th, 2023

Know Thyself

The S&P 500 is roughly where it was two years ago, around 4,000. But during this short time frame, it has visited 4,800 (+20%) and 3,600 (-10%) – clearly not a flat journey. The TSX has fared better, starting at 18,500, rising up to 22,000, back down to 18,500 and then up to 20,000. Meanwhile, most bonds lost a little money in 2021 and a sizeable amount in 2022…certainly a challenging investment market. Of course, we have seen worse periods for markets, and fortunately, we have often seen better. There is a silver lining for the past two years, even if your portfolio has become a tad smaller. The scenario of events has created a great environment to understand yourself as an investor (or understand your clients' behaviours better).

Bear with me.

The past two years have seen very big ups and very big downs across many parts of the market. Rampant speculation to despair in certain areas. From free money to money that has a real cost again. Growth to value, QE to QT, peace to war. Add bonds not protecting the portfolio very well as inflation rose. This market, with all its crazy moves of late, has been near perfect for helping you understand what kind of investor you are.

2021 vs 2022

Were you enticed or contemplated dabbling in the high-flying meme stocks of 2021? Or the profitless tech disruptors that sounded like they were about to change the world? Flying autonomous taxis and such. Or even the more 'conservative' dabbling in those mega-cap tech names. Did you feel like or take on more market exposure during the upswing in 2021?

Turn to 2022, had you considered selling. I mean, cash now pays 4%+. So who needs this market risk anymore? And there could be a recession coming. Maybe the flying cars are not imminent, or maybe the market is starting to value Tesla as a company that makes cars. Or those bonds that really dropped the ball as a portfolio stabilizer in 2022 – done with them and moving to those that did better? Those happen to be the strategies with more credit exposure.

The simple fact is we are naturally drawn to investments that have performed better and away from those that have performed poorly. And during the past two years, many investments have flip-flopped from good to bad or vice versa. This created a ripe environment to test your fortitude to remain on your financial plan, or maybe it enticed you off that plan in the hopes of gains or ending performance pain.

Unfortunately, positive performance chasing or poor performance fleeing are two behaviours that can really mess with long-term returns. Dalbar Inc. analysis highlights this behaviour with their money flow analysis showing the average U.S. equity investors experienced 7.1% annualized gains over the past 30 years while the S&P 500 index gained 10.6%. This is due to performance chasing in both directions. This can also be seen in mutual fund allocations over time. While this is U.S. data and only incorporates funds, the lesson remains valuable.

Money market allocations

Behavioral Coaching

Of course, examples of the "average investor" often elicit the response, "well, that isn't me." So to make it a bit more salient, consider the wealth damage capitulation can cause.

Take the example in the chart below. Investors A & B capitulate at the bottom of the pandemic, and who would blame them? Those were scary times, and for an investor with little experience in significant market corrections (the last one being way back in 2008), emotions can take over and cause a mistake. However, to an inexperienced investor, it does not feel like a mistake at the time. You initially invested $10,000, and it is now below $6,000; you just want the bleeding to stop. Therefore, the band-aid for an investor is to sell the investments and go to cash.

Fast forward to the future, Investor A reinvests the same capital six months later. In this scenario, the market has largely recovered back to pre-pandemic levels. However, they have missed out on much of that initial growth off the bottom and end up in a significantly worse position today than if they had the wherewithal to remain invested. Investor B is in a similar position, but instead of waiting six months, they wait a full year until they are comfortable. This allows them to miss out on approximately $6,100 of capital gain in the market.

This is what we like to call the "Cost of Fear." For investment professionals, charts like the one below have been around for a long time. It is not a new revolutionary concept. But it visually represents a common mistake investors make: selling low and buying high, if you will. Market corrections happen, and they are healthy for an efficient market environment. But if you leave the market, I hope you have an expensive crystal ball because it is nearly impossible to pick the correct time to return.

Capitulation at Market Bottom

This is where investing and psychology have an immense overlap. Money is emotional, and for the most part, the stock market is not a tangible purchase you can touch, like real estate or a painting. For some reason, we as investors feel we need to value our portfolios daily, checking stock prices etc. When on the other side, those tangible investments we are comfortable with checking the value of them maybe once a year, probably every two years. So what about the stock market makes us feel like we have some form of control? The market will do what it wants to do. The mistakes come from investors admitting defeat. This is why investment and portfolio construction advice is paramount, avoiding those A & B return paths and reaching retirement goals faster than expected.

Final Thoughts

Financial advice takes many forms, from planning, tax, and portfolio construction, to mention a few. However, during times like the past few years, behavioural coaching may actually add the most value. Helping investors avoid making those emotional mistakes that can cause long-term portfolio performance damage. We are not saying the market will go up from here in either equities or bonds. But focusing on the long-term journey can help mitigate the dangerous tendencies that market volatility can elicit in the short term.

Take stock of your behaviours and feelings about investing over the past few years. Understanding your personal tendencies with an objective lens can really help your own decision-making process during periods of market volatility. And understanding can help avoid or mitigate damaging performance behaviours.

"To know thyself is the beginning of wisdom." - Socrates

— Craig Basinger is the Chief Market Strategist at Purpose Investments
— Brett Gustafson is an Analyst at Purpose Investments

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Sources: Charts are sourced to Bloomberg L. P.

The content of this document is for informational purposes only and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document, and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.

Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Certain statements in this document are forward-looking. Forward-looking statements ("FLS") are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as "may," "will," "should," "could," "expect," "anticipate," intend," "plan," "believe," "estimate" or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

Craig Basinger, CFA

Craig Basinger is the Chief Market Strategist at Purpose Investments. With over 25 years of investment experience, Craig combines an educational foundation in economics & psychology with years of experience in both fundamental and quantitative research. A long-term student of the markets, Craig’s thoughts and insights can be seen in his Market Ethos publications and through his regular contributions on BNN.

Craig and his team bring a transparent and cost-efficient approach to investment management. The team provides asset allocation OCIO services and directly manages over $1 billion in assets. The team manages dividend mandates, quantitative risk reduction strategies and asset allocation services.

Brett Gustafson

Brett is a Portfolio Analyst at Purpose. He is responsible for relationship management and advisor support and focuses heavily on portfolio analytics for advisors, our own proprietary models, as well as equity research. With over nine years of experience in the investment industry, Brett started his career out as an Investment Advisor at a Canadian independent asset management firm where he cared for several high-net-worth families. Brett graduated from the University of Calgary with a Bachelor of Commerce degree. He is currently pursuing his CFA designation with the goal of becoming a Portfolio Manager.