Stock-market gains are making us dangerously complacent …
During a recent chat with a long-time investing-minded friend, the topic naturally drifted to the recent strong market performance and what that meant for our goals.
Perhaps like many others, our goals can be broken up into two separate but related hopes. One, the mildly optimistic version, is that we save and generate enough investment returns to retire comfortably — live a similar standard of living, occasional vacations, help our families or future kids if needed, and generally enjoy a bit of everyday life.
The other goal, the wildly optimistic version, is spectacular investment returns such that the income generated is enough to replace, not supplement, our full-time jobs altogether. Early retirement, living the life while you’re still young enough to venture forth — it’s admittedly bit of an indulgent dream.
As our conversation went from market results to our market gains and goals, I noticed there was a much more optimistic tone to the discussion than in the past. Instead of being a dream, maybe the wildly optimistic goal was possible? In that discussion, there was surprisingly hardly any undercurrent of fear, of concern the market will drop, or that we will lose most of our invested money.
I began to wonder why that was. Then I looked at the numbers and it was quite obvious. We’ve now had three straight years of double-digit returns on the S&P 500, five if you skip 2011 with its measly 2.11% gain. We’ve had 6 straight years of S&P gains with a 158% increase since the end of 2008. We haven’t had a down year in over half a decade now, ironically at a time when the dominant economic narrative was a new normal of stagnating growth.
And even though we’re only in February, the S&P 500 is already up 2.7% this year — an annualized return of over 15%. It almost feels like nothing can go wrong.
Recency is an important factor in human mentality. Back when we were running from cave to cave, we didn’t care what happened there 10 years ago, last night’s outcomes were much more important. And thus our brain has made it easy for events to retreat and be lost in the fog of time. Statistics show 10%-15% corrections tend to happen every one to two years. Today, we haven’t had a 10% correction since 2011 — more than enough for people to forget what that feels like.
Even last week when Greece was potentially on the brink of financial catastrophe and Grexit was looming…nobody cared. The S&P didn’t notice at all at what was once one of the most feared domino events in the post-financial-crisis era. Even Germany’s stock market has pretty much shrugged at the entire thing.
Complacency is now the norm and that is terrifying. There are real risks out there in the world — the bogeyman isn’t dead, he’s just waiting for the next opportunity. The efficient-markets hypothesis has been a great theory to explain much of what we see in the markets but it only works when there are people on both sides pushing and pulling to make sure prices and expectations don’t go too far up or down.
Too much complacency also breeds excessive risk aversion when conditions change. If all you’ve become accustomed to is the market going up, well when the market falls, many are going to panic hard and panic fast. And you’re likely to sell. Most studies found you’re likely going to sell close to the bottom. Buying low and selling high rarely happens; many people tend to buy high and sell low instead.
Deep down, you know that you should buy and hold and just ride out the volatility wave but emotions and panic will likely override your better judgment. Studies have proven time and time again that bad psychology is one of the worst enemies of successful investing.
So what should you do? Look at your portfolio, and do some what-if exercises. What if your biggest holding drops 1% a day for 10 days in a row? What if the market drops 20%? What if the EU announces a breakup? What if every friend, analyst, or talking head yells to “sell, sell, sell”?
Imagine your possible reactions now while you are still cool and collected. Write out some firm plans, suggestions, or even reassurances. Maybe tell yourself just how long your horizon really is, remind yourself how you successfully (or unsuccessfully) navigated the financial crisis and that this is nothing, or that buy and hold on diversified assets is a proven method. Perhaps if you really need to, put down some logical numbers and rational conditions for what will make you sell a holding.
Now put that plan in an envelope, seal it, and put it on your desk with a note that says “open only in case of utmost financial market panic.” Then relax…but only for a bit.
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Stock-market gains are making us dangerously complacent …
