Yesterday I read an excellent post by Corey Hoffstein of Newfound Research. He discussed the recent market volatility, and suggested that many investors might feel worse about it in comparison to other very similar corrections. The reasoning he provided makes a lot of sense to me:
“At peak on July 21, 2015, the S&P 500 was up only approximately 4%. So it wasn’t long before we hit negative year-to-date numbers and it looked like we dipped into “real loss” territory.
So despite the fact that the drawdown in the S&P 500 is only about -12% at the moment – less than both 2010 and 2011 – this sell-off might feel much worse to an investor who is looking at their year-to-date number. At a -12% drawdown in 2010 and 2011, markets were only slightly down – not the -8% we’re down now.”
Corey’s main point is that year-to-date return is probably not the right number for a long term investor to consider when examining their portfolio. I agree, and also believe that year-to-date returns likely contribute to many common investor errors made during periods of market volatility.
What this ultimately boils down to is framing. Framing can be used for good and for evil. It’s been said that if you torture numbers, they’ll confess to anything. This is true, and you always need to consider sample sizes, sources, and slants when data is presented. However, I believe investors have the ability to make framing work for them in a positive way.
When investing for the long term, sampling random January through December periods from your portfolio’s history can be deceiving. Why not October through September? Why only measure in 12 month increments? So many investors have become slaves to the calendar year. If your investment time horizon is 20+ years, why would you get hung up on what happens in any one of them individually? It’s only a piece to the puzzle, after all. It would be like me freaking out because the Mets got outscored 1-0 in the second inning by the Phillies. That inning is 1/9 of the game’s final outcome, and 7/9 of the game has yet to occur.
Monitoring and tracking the progress of a portfolio over time is important, but we need to find a better method than year-to-date returns for long term investors.
I think this is where framing can be used for good. A better way to measure a portfolio’s progress is to look at what it’s done since inception, and then place that progress in the grand scheme of your long term goals. Examining things in this light may be able to help investors relax when the market is experiencing a correction. I realize this is just a different form of “torturing the numbers”, but it’s probably a healthier one. Anything that helps realign a long term investor’s mindset with their time frame is alright in my book.
When you’re a long term investor, the game never resets. Measuring your portfolio’s progress accordingly might keep you from panicking during market corrections.
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