Our second quarter report reviews the market and economic environment, our investment strategy and discusses some of the behavioral challenges that accompany investing.
The Ebb & Flow of Markets
One of the most challenging aspects of investing is sticking with a prudent and disciplined approach throughout the natural ebb and flow of world markets. Investors are driven by powerful emotional needs and desires often without consciously being aware of them. Behavioral biases like fear, greed, regret, overconfidence, loss aversion, and others frequently challenge the achievement of financial success. Whatever the behavioral biases, we must recognize that they are present and can come with a price, sometimes one that is substantial.
A study by Dalbar for the 20 year period ending 12/31/2015, revealed the average investors annualized return was 2.5% versus 9.2% for stocks and 5.7% for bonds. This was a period ripe for behavioral mistakes with two large asset bubbles and subsequent draw-downs, one associated with Technology and the other with real estate and the 2008 credit crisis. Clearly investors biases weighed on actual investment results.
There are no lack of issues to throw investors off-course. Recently, we have seen investors challenged by the highly charged political environment. This chart illustrates the Philadelphia Federal Reserves Partisan Conflict Index, which attempts to measure the degree of political disagreement among U.S. politicians at the Federal level. According to the Philadelphia Fed’s calculations, the environment in Washington has never been more divided than it is today. The natural response of people is to allow political beliefs to feed into investment decisions.
We believe it is a mistake to mix partisan politics and investing since the markets are completely apolitical, prioritizing corporate profits and other fundamental factors into returns not political opinions. Warren Buffett agrees, stating in February that it does not make sense to mix political views with investment activities. Here again the data is supportive. One might suspect during a period of high partisan conflict that market returns would be compromised. In fact, results have been just the opposite. During periods of higher partisan conflict, one-year forward returns for the S&P 500 have been 13.2% versus 7.3% when partisan conflict was below average.
At Hefren-Tillotson, we seek to address behavioral biases through our team approach, which allows professionals to express views and collaboratively determine a path forward. In a similar manner, we strive to identify and address biases that naturally challenge our clients. Having a relationship that serves as a check on emotionally-driven decisions can be hugely valuable over time and is a key advantage of working with a trusted Advisor.