Behavioral Finance

The phrase “On your marks” is used to instruct competitors in a race to prepare themselves in the correct starting position. This was telegraphed to US citizens on July 21, when Joe Biden bowed out of the Presidential election contest.

PredictIt is a New Zealand-based online prediction market that offers exchanges on political and financial events. The benefit of allowing people to put their money where their mouths are, when it comes to politics, is that we get an unvarnished view as to what people really think of who will win an election.

Here’s a chart of how folks were laying bets around the outcome of the US Presidential race from mid-April through mid-July.

The spread between Trump and Biden / Harris widened substantially following Biden’s poor debate performance in late June.

And here’s an updated 90-day picture, as of July 31, ten days after Biden bowed out.

It indicates that momentum is favoring Harris, who now has a slight lead on PredictIt.

The betting market confirms what recent opinion polls are saying: the race for US President is currently in a statistical dead heat.

Many of us have strong feelings about the people who run for office and take on the responsibility to represent us in government.

Because politics touches many parts of our lives and plays a role in how we as a nation are perceived by others in the world, it’s understandable why a presidential election stirs sentiment.

However, when investing, it’s advisable to set emotions aside.

Policies, not personalities, are likely to have the greatest impact on financial markets in the years ahead.

 -RK

For some investors, risk is a dreadful word. Risk is associated with downside and loss. Good if it can be mitigated; better if it can be avoided; best if it can be eliminated altogether.

If asked to visualize their perception of risk in canine terms, the risk-averse investor’s image of risk may look something like:

This attitude may stem from learned behavior (perhaps from parents or grandparents that lived through a life-altering event like the Great Depression of the 1930s) or from personal experience (maybe by having lost sizable sums during the Global Financial Crisis of the mid-aughts).

For other investors, risk is perceived as a necessary evil. They know that compounding is an important factor in capital accumulation.

To facilitate compounding at a satisfactory rate, they accept the risk (as discomforting as it may be) that comes with their targeted rate of return.

Fewer people associate risk with opportunity. The idea of risk as an attractive feature of the investment landscape may seem strange.

However, learning to view risk through a lens of opportunity can be good for your wealth and important for your peace of mind as an investor.

Being able to envision risk as something with beneficial aspects – though requiring regular attention and sometimes tricky to manage – is a more desirable orientation. The risk-tolerant investor’s view of risk (again, in canine terms) might be pictured like this:

In his latest client memo, the professional investor and author Howard Marks, the co-founder of Oaktree Capital Management, talks about “the indispensability of risk”. Here are a few illuminating quotes on the nature of risk:

• As five-time world chess champion Magnus Carlsen put it, “not being willing to take risks is an extremely risky strategy.”
• Investors must accept that success is likely to stem from making a large number of investments, all of which you make because you expect them to succeed, but some portion of which you know won’t.
• Not every effort will be rewarded with high returns, but hopefully enough will do so to produce success over the long term… refusal to take risk in this process is unlikely to get you to where you want to go.
• You have to sacrifice certainty (as an investor) but it has to be done skillfully and intelligently, with emotion under control.
• The risk inherent in not taking enough risk is very real. Individual investors who eschew risk may end up with a return that is insufficient to support their cost of living.

Marks’ words are helpful in validating the need to take risk and in reminding us that, while some investments are likely to fall short of our return expectations, a willingness to bear risk in an intelligent and controlled manner facilitates investment success.

The last point from the above list seems most relevant to those who are approaching, or in, retirement – and thinking about longevity. It is worth restating: the risk inherent in not taking enough risk is very real.

The financial planning process is a particularly useful way to assess portfolio risk as it facilitates:

• understanding the current level of risk you have
• calibrating the degree of risk you need
• knowing when to adjust other parts of your financial plan if the risk in your portfolio changes suddenly

For those who have a high level of concern when it comes to taking financial market risk, we find that our suite of financial planning tools can help improve risk visualization and raise the comfort level for maintaining a level of risk that supports a financial plan over the long term.

If you envision bared teeth and sharp claws when you hear the word risk, please let us know.

We’d like to use our expertise and planning tools to begin shifting your perception of risk, and to help you see it as a beneficial and desirable aspect of investing and a necessary part of your financial plan.

 -RK

Anticipatory anxiety describes when people experience worry and apprehension for a future event that may or may not occur. It can begin anywhere from minutes to years before an anticipated event.

People can experience anticipatory anxiety when awaiting an upcoming personal task, like a job interview, or when thinking about unforeseen dangers, like natural disasters.

Individuals experiencing this condition can be overwhelmed by negative thoughts and what-ifs. They often expect the worst and sort through every possible bad outcome, becoming unable to focus on anything else.

Hopefully you do not suffer from acute anticipatory anxiety triggered by your investments. If this is the case, Susan and I will do our best to help. Reaching out to other professionals who counsel in different ways might also be appropriate.

It’s entirely possible that you might be experiencing anticipatory anxiety episodes (but not an acute condition) after living through the financial markets’ wild swings and selloffs of 2022. You’re likely now wondering what’s in store for 2023.

Susan and I encourage long term thinking. This includes building financial plans that extend well into the future and constructing portfolios with well-diversified asset allocations that help clients achieve life goals.

Focusing on long-term financial plans and future outcomes can help relieve anxiety about what will happen in the markets tomorrow or next week. Attempting to forecast what will happen next month, or next year, does little to support long-term thinking.

Yet it’s just human to want to know what comes next. We understand this, too. And we realize that having a framework for thinking about what may lie ahead in 2023 for the financial markets may also help calm anxiety related to your investments.

There are many folks at large financial firms who are paid to work up ‘year ahead’ forecasts, and they tend to share their views around this time of the year. Do the Wall Street Wizards really know what will happen in 2023? Of course not.

But these forecasts can be useful even if they’re not right because they provide a reference point to guide our decisions.

On January 2, 2023, Bloomberg, the news and data service, compiled opinions from researchers, analysts, and economists at fifty large financial firms.

While there are outliers – for example, a researcher at Piper Sandler, known as Wall Street’s ‘Top Bear’, sees stocks sliding another 16% in 2023 – most are more sanguine.

After reading through the projections from the large financial firms, here’s my take on what the consensus forecasts for the year ahead looks like:

• Economy: things get worse before they get better; there will be a recession in the US, but likely a mild one, with the economy recovering toward year’s end
• Inflation: continues to decline, reaching 3% – 4% by year end, but still higher than ‘normal’
• Federal Reserve: stops raising interest rates by springtime
• Short-Term Interest Rates: reach a high of 5.25% (currently 4.5%)
• US Dollar: will weaken versus other major currencies
• Company Profits: likely to decline in 2023
• Stocks: likely to decline in the first half of 2023, possibly improve in 2nd half; don’t expect a lot from stocks this year

Bracing oneself for the potential rocky ride in stocks during the next year is probably a prudent approach.

However, recognizing that there are many possible paths the financial markets could travel, and being open to the potential of a better future for stocks and bonds (maybe even in 2023) is important for your psychological well-being and encourages perseverance in your investment approach.

RK