By Dylan B Minor PhD, MS, CFP®, CIMA, ChFC, CLU
“With the past, I have nothing to do; nor with the future. I live now.”
Ralph Waldo Emerson
Living in the present is advice I frequently hear from different corners of the world: we must leave the shackles of the past, put off the burden of the future, and live for the now. This can be good advice for everything from enjoying yoga to getting ready to serve in a tennis game on break point, standing at match point. The advice turns out, however, to be awful when making financial decisions.
Pernicious manifestations of “present living” in investing arise when one makes choices based on the most recent year (or even, month or week!). Whether selecting an asset class or a particular investment, there is a strong attraction to simply picking the one investment that has had the most recent greatest return. One of those investments right now is US stocks. They have had a tantalizing return of some 18.6% over the past year, as measured by the SP500 through June, 2014. With such impressive returns, the “longer term” can all of a sudden look quite different. For example, if stocks had three years of return of: -10%, 5%, and 7%. This yields a 3-year annualized return of roughly 0%. Now, assume that stocks enjoyed a 20% return the following year. This yields a trailing 3-year annualized return of over 10% per annum! Hence, a single good year can make things look quite different and mask past adverse periods. In this example, when we think of stocks earning over 10% per annum (and 0% per annum), we are living in the present. The trouble comes when after witnessing a 20% return we feel that this investment is “now” such a higher returning investment (even for three years!) compared with our other investments. This all too common experience can create a nasty cycle of buying high and selling low. This tendency is often brought into full relief when it comes time to rebalance our portfolios; we hear our Omega advisor suggesting that you trim some stocks after they enjoyed a 20% gain and put these proceeds into managed futures, which had eked out a meager 1% per annum gain over the past five years. “But stocks are doing so well!” we naturally protest. Similar protests erupted in late 2007 and 1999 before major stock market crashes. And then again in the other direction when we started trimming managed futures and bonds and reallocating them to stocks, after stocks had dropped around 50% in value. “But bonds and managed futures are doing so well!” we often heard.
Despite these anecdotes, is it really true that investors tend to fare so poorly living in the present? Unfortunately, recent empirical evidence suggests that it makes a big difference. The Investment Company Institute found that over the past 5 years, in the midst of our dramatic US stock recovery, investors made net withdrawals from stock funds, while adding on net over 1⁄2 trillion to bond funds, reacting to the present returns. Meanwhile, stock funds outperformed bond funds over 4 to 1 over this period. Of course, now with the recent run up in US stocks, the tide is beginning to turn the other way. Over an even longer period, for 20 years, Dalbar found that the average investor captured less than half of the market returns of the very markets that they were investing in. Most of this can be attributed to “living in the present”: deciding investment allocations based on what has most recently done the best. Ask your Omega advisor for a recent webinar that explores this phenomenon in more detail, as well as some behavioral biases that tend to drive it.
So what should we do now? It is quite possible that US stocks will continue a magnificent run for quite some time. Although, in my view, the overall economy is still recovering in staggering fashion, some prominent investment firms like Goldman Sachs have just recently said they are now bullish on US stocks, throwing off their extant bearish stance. See here for a recent article on this flip flop. If instead you want to hear a bearish argument (and you want to live in fear), simply conduct a Google search on the soon, inevitable fall of the stock markets, and even the entire financial system, if not all of planet Earth, perhaps to some virally infested apes. Dr. Doom, formally known as Nouriel Roubini, is a great place to start, though we do not recommend starting.
Instead, the solution, in my view, is to continue managing financial assets that are optimally integrated through complementary correlations. This means by definition that various parts of your portfolio will go up and down at different times. It also means that there are (almost) always things in a portfolio that you wish you didn’t own, when living in the present. And others that you wish you solely owned, when living in the present. But instead, with a portfolio designed through our Optimized Wealth Integration® approach, we can use our strategic target allocations to periodically rebalance. This forces us to leave the present and instead live independently of the present times: to cyclically sell high and buy low. Although it certainly does not turn out this way every quarter, historically engaging in such a process has been handsomely rewarded, and it is these kinds of rewards that are ultimately enjoyed in the present. So during your next visit with your Omega advisor, with a big, warm smile, remind them that you do not want to live in the present, but instead transcend time. You’ll be rewarded with a bit of a surprised, if not puzzled look…
This commentary reflects the personal opinions, viewpoints and analyses of the Omega Financial Group employees providing such comments, and should not be regarded as a description of advisory services provided by Omega Financial Group or performance returns of any Omega Financial Group Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Omega Financial Group manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.