The Blueprint
Are you Overconfident?
The Importance of Objective Risk Management
“Be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett made this comment in his shareholder letter in 1986. Not more than one year later, we witnessed “Black Friday” on Oct 19, 1987 when the Dow Jones plunged 22.6%, its largest single day percentage drop. We have experienced many markets where investors would have been wise to follow Mr. Buffett’s advice, but time and again we see people doing the opposite.
Are investors overconfident today?
Over the past 20 years, we have witnessed a significant increase in market volatility. Not only did we have two of the greatest bear and bull markets of our lifetime (the Internet Bubble from 2000-2002 and its subsequent recovery; and the Financial Crisis from 2007-2009 and its subsequent recovery), but just last year we experienced the COVID bear market which was the quickest stock market decline on record. The S&P 500 dropped ~34% over 33 days only to fully recover 140 days later1 and the bull market is still intact today. As of April 20, 2021, the S&P 500 is up 88% from its March 23, 2020 COVID bear market low2, and International stocks (as represented by the MSCI ACWI) are up 86% during the same period.3
Each of these bear and bull markets were unexpected. Many investors were caught off guard and, as a result, wound up making poor investment decisions buying at or near market highs, selling at or near market lows, or worse they did both. These types of mistakes can lead to significant underperformance and prevent individuals from achieving their long-term financial goals. Today with most major indices trading at or near all-time highs, and an unprecedented run in some of the most speculative parts of the market, we have to wonder how many investors are experiencing an overconfidence bias.
What is overconfidence bias?
As it pertains to investing, overconfidence bias often leads people to overestimate their understanding of financial markets or specific investments, and disregard data and insight that differs from their own. It can lead us to view our investment decisions and portfolio allocation as less risky than they actually are. This frequently results in ill-advised attempts to time the market or build concentrated positions in risky investments one believes are a sure thing.
While confidence is commonly considered a strength in many parts of our lives, when it comes to investing it can work against you. The problem is, in the short-term, markets aren’t rational and tend to have a mind of their own. Therefore, we cannot predict the direction of the market from looking at a chart.
A false sense of confidence can be detrimental to the long-term outcomes of any portfolio. During bull markets, this confidence tends to help investors stay the course, sticking to a Buy and Hold mentality. However, during major market corrections, many investors let their emotions overwhelm them, and often make significant negative modifications to their investment portfolios. At this point investor euphoria turns to fear, and overconfidence turns to doubt.
Buy and Hold Works Until It Does Not
Historically Investors tend to buy and sell based on the recent performance of the market
Source: ETF Flows: Morningstar, US ETFs, Include Obsolete Funds, Mutual Fund Flows: ICI.org, Domestic Equity, S&P 500 Total Return Index: YCharts, 1/1/2007 – 10/31/20
Past performance is not indicative of future returns.
Swings in the markets and emotions are to be expected over a full market cycle. Historically, money tends to flow into equity investments during strong markets, and flow out during major market corrections. As you can see in the chart above, investors liquidated funds as the market fell during the financial crisis in 2009, and continued to do so even as the market began to recover. However, a significant amount of money did not come back into the equity markets until 2014, well after the market had bottomed. Did emotions take over and force investors to act out of fear, or were investors trying to time the markets? Either way, history suggests that neither one of these decisions tends to prove productive.
A Different Approach
At Blue Square, we are focused on risk management and seek to reduce the amount of volatility in our clients’ portfolios. Using our proprietary technology and rules-based approach to investing, our decisions are not swayed by predictions or emotions.
Our investment strategy aims to position portfolios defensively during significant market declines. By systematically raising cash during these periods and then investing it when markets are more accommodating, we aim to create a less volatile investment experience, and ultimately deliver better risk-adjusted returns over full market cycles.
At Blue Square rather than trying to predict the future, we aim to prepare for it, regardless of the market’s direction. Should you have any questions or would like to discuss our strategy and capabilities in more detail, please do not hesitate to reach out and we would be glad to help.
1): Source: Ycharts S&P 500 TR 1/1/2020 – 8/10/2020
2) Source: : Ycharts S&P 500 TR 3/23/2020 – 4/20/2021
3) Source:Ycharts MSCI ACWI TR 3/23/2020 – 4/20/2021
Past performance is not indicative of future returns. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
This document may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “should,” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. Neither Blue Square nor any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.
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All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio. Past performance is not indicative of future returns.
Significant risk may accompany investments in stocks, bonds or other asset classes over short periods of time. Investment return and principal value will fluctuate with changes in market conditions. Your investment may be worth more or less than your original cost. Past performance is not indicative of future results.
This blog is a publication of Blue Square Wealth. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of subjects discussed. All expressions of opinion reflect judgment of author as of date of publication and are subject to change. Information contained herein does not involve rendering of investment advice. A professional adviser should be consulted before implementing any of strategies presented. Information is not an offer to buy or sell, or a solicitation of any offer to buy or sell securities mentioned herein. Different types of investments involve varying degrees of risk. Economic factors, market conditions, and investment strategies will affect performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. This document may contain forward-looking statements relating to objectives, opportunities, and future performance of U.S. markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “should,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to economic conditions, changing levels of competition in industries and markets, changes in interest rates, and other economic, governmental, regulatory and other factors affecting a portfolio’s operations that could cause results to differ materially from projected results. Such statements are forward-looking in nature and involve known and unknown risks, uncertainties and factors, actual results may differ materially from those reflected in forward-looking statements. Investors cautioned not to place undue reliance on forward-looking statements / examples. None of Blue Square Wealth or any affiliates, principals nor any other individual / entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances.