BY JOSEPH MATTHEWS
What to do? Markets are at new highs, interest rates remain low and record amounts of cash still sit on the sidelines earning less than 0 percent after taxes and inflation. For the individual investor, identifying investment opportunities is as perplexing today as it has ever been. Worries about terrorism and global geopolitical issues, a 5-year-old economic expansion and recent changes in Federal Reserve open market actions surely are causing anxiety for investors. Throw in the lingering pain from the 2008 financial crisis and it is no wonder many investors are still not as engaged in the stock and bond markets as they should be ”“ and need to be. Unfortunately, these factors as well as others ”“ both personal as well those beyond our control ”“ can cloud the ability to make informed, rational investment decisions.
Everyone is prone to biases that affect decisions. One example: the investor unwilling to sell stock in “Dad”™s company” despite more attractive investment opportunities (anchoring bias). Another example: ignoring facts that refute original reasoning behind an investment in exchange for finding anyone or anything that endorses the now-flawed thinking (confirmation bias). Then there is the investor only buying stock or bonds in companies they “know” (familiarity bias).
These and other types of behavioral mistakes can significantly reduce the probability of reaching investment goals. While some learn from mistakes and improve as investors, many look back with a reconstructive memory and choose to distort reality (hindsight bias).
A review of the markets and economy reveals interesting fact patterns. For example, the U.S. bond market ”“ as measured by the Barclays Aggregate Bond Index ”“ has generated positive rates of return in 30 of the last 33 years. The three years of negative returns (1994, 1999 and 2013) were all in the low single digits. As measured by the Standard & Poor”™s 500 Index, stocks have generated positive returns in 78 percent of the last 85 years. During that same time period, stocks were down 20 percent or more in only six calendar years while generating 20 percent or greater returns in 31 years. When looking at the U.S. economy, the average length of an economic expansion is 58 months with the average contraction lasting 11 months. The longest expansion in the U.S. was 10 years.
I believe that a serious look at the stock market suggests we could be in for a pullback while the bond market will likely be less favorable to holders of long-term bonds. That said, there has been a lot of good work Americans ”“ both individuals as well as corporations ”“ have done in the last few years getting their financial houses in order. However, world economies are clearly not in sync (i.e., Europe”™s recession versus the U.S. expansion). Because of these and other factors, I believe the current expansion can go on longer than most investors expect. Well-diversified portfolios probably won”™t experience returns over the next few years that they have over the last five, but returns for well-diversified portfolios relative to cash and risk still appear to me to be attractive.
Most investors rely on their portfolios to fund future liabilities like retirement or college. Three things should be considered: investment time horizon, liquidity needs and risk tolerance. Yet the task of constructing and maintaining a portfolio can prove to be monumental.
As humans, we all are prone to a particular bias that can blindside: overconfidence. As investors, we need to be true to ourselves and take a realistic view of our strengths and weaknesses. An annual study conducted by Dalbar shows investor returns varying significantly from overall investment returns. Its most recent study shows the average mutual fund investor”™s annual returns over the 20 years ending in 2013 as 5.02 percent while the S&P 500 was up 9.22 percent. Worse yet was the return for the average asset allocation mutual investor with a rate of return of 2.53 percent over the same time period. This is easily addressable by identifying and sticking with a definable and repeatable investment processes consistent with objectives.
With that in mind, it is in the best interest of most investors to manage themselves as diligently as they desire their portfolios be managed. As the late, great Peter Drucker told his readers in “Managing Oneself,” “”¦ a person can only perform from strength. One cannot build performance on weaknesses, let alone on something one cannot do at all.”
Joseph Matthews is the Fairfield office manager and senior investment management consultant with the Global Wealth Management Division of Morgan Stanley Wealth Management. He can be reached at 203-319-5165 or by email at joseph.matthews@morganstanley.com.
