Is that a lion lurking yonder, or a breeze rippling in the grass? Our talent for cleverly connecting cause and effect dates back to the dawn of civilization, at least for those of us who are still participating in the gene pool. No wonder investors display a strong tendency to respond to perceived market patterns – even when those patterns turn out to be shadows of fleeting clouds.
Market Patterns, Real and Perceived
Are there signs to tell us if a market correction is imminent, or are they more likely false prophets? Either way, how is an investor advised to respond to such forecasts? In the market, investors are best served by being aware of which patterns are worth heeding and which can and should be ignored.
From an empirical viewpoint, it’s relatively easy to tell the difference. Real patterns are the ones that rigorous, peer-reviewed academic inquiry have identified as persistent across time, geography and market conditions. They are the ones upon which you can expect to build and sustain your long-term portfolio. For example:
- Stocks tend to earn more than bonds over the long-run, but they generally represent a bumpier ride requiring more risk tolerance. Similarly, riskier categories of stocks, such as small versus large companies and “value” versus growth-oriented companies have delivered premium returns over time, at least for those who have been able to tolerate the increased volatility along the way.
- Minimizing costs tends to be among the most effective strategies you can employ in your quest for higher net returns.
- Changing your portfolio in reaction to forecasts of imminent market corrections (or of any other predicted market shift) is more likely to help than to hurt your end returns, not to mention your levels of personal anxiety.
On that last one, even if logic informs us that it’s expensive and ill-advised to hunt or flee every impending market event we may perceive, our pattern-loving instincts can cloud our better judgment. In his article, “Connecting the Dots,” Dimensional Fund Advisors’ Australian Vice President Jim Parker describes how the tendency to be fooled by false patterns is universal, and often universally aided and abetted by the global popular press:
“For individual investors, financial news can be distracting. All this linking of news events to very short-term stock price movements can lead us to think that if we study the news closely enough we can work out which way the market will move. But the jamming of often-unconnected events into a story can lead us to mix up causes and effects and focus on all the wrong things.”
In investing and many other walks of life, our ability to accurately judge cause and effect serves us well. For example, I like to let my children take modest, developmental risks, such as my daughter’s recent adventures in fashion design. But if I see them running too fast toward a busy street corner, I know better than to wait and see what might happen if I let them have their way.
In the market, investors who are best equipped to go the distance are those who are equipped with a two-pronged defense: 1) the empirical understanding they need to differentiate real, evidenced-based risks and opportunities from emotional, instinct-driven perceptions and (2) the emotional stamina to invest accordingly.
For more information or to set up a consultation, contact Pathway Financial Planning at or email firstname.lastname@example.org.