“People have a strong tendency to go along with the status quo or default option.”
“Unrealistic optimism is a pervasive feature of human life; it characterizes most people in most social categories. When they overestimate their personal immunity from harm, people may fail to take sensible preventive steps.”
“For reasons of laziness, fear, and distraction, many people will take whatever option requires the least effort, or the path of least resistance.”
“No sensible definition of prudence can accommodate a concentrated position in a single stock—especially if that stock’s performance is correlated with participants’ work earnings.”
Richard Thaler
Nobel Prize in Economics 2017
Behavioral Finance Professor – University of Chicago
Markets
The markets continue to move upward as shown by the indices below.
| Periodic Performance | ||||||
| By 09/2017; Default Currency: USD, % | ||||||
| YTD | 3 Mon | 1 Year | 3 Years | 5 Years | 10 Years | |
| S&P 500 | 14.24 | 4.48 | 18.61 | 10.81 | 14.22 | 7.44 |
| Russell 2000 | 10.94 | 5.67 | 20.74 | 12.18 | 13.79 | 7.85 |
| Russell 2000 Value | 5.68 | 5.11 | 20.55 | 12.12 | 13.27 | 7.14 |
| MSCI World ex USA (net div) | 19.17 | 5.62 | 18.73 | 4.57 | 7.81 | 1.28 |
| MSCI World ex USA Small Cap | 23.82 | 7.26 | 20.42 | 9.59 | 11.16 | 4.04 |
| MSCI Emerging Markets | 27.78 | 7.89 | 22.46 | 4.90 | 3.99 | 1.32 |
| Bloomberg Barclays U.S. Treasury 1-5 yrs | 1.09 | 0.29 | -0.10 | 1.16 | 0.82 | 2.37 |
| BofA Merrill Lynch 1-Year US Treasury | 0.55 | 0.25 | 0.60 | 0.46 | 0.39 | 1.05 |
Emerging markets outperformed developed markets, including the US, during the quarter. The value effect was positive in non-US developed markets but negative in the US and emerging markets. Small caps outperformed large caps in US and non-US developed markets but underperformed in emerging markets. The benefits of diversification showed in dollar terms, as developed international markets outperformed US equity indices also.
Richard Thaler Wins Nobel Prize – Why it Matters
Richard Thaler became the second person to win a Nobel Prize for behavioral finance, following in Danny Kahneman’s footsteps. His win is important because his insights have real impact for advisors helping their clients obtain better long-term results.
Thaler’s contributions to finance are many, but I believe one of his greatest is his finding that people will take the path of least resistance, even if such path is not optimal to their long run future. As a consequence, Thaler encourages “if you want to get people to do something, make it easy. Remove the obstacles.” Since investing, including portfolio construction and financial planning, is hard for a majority of people, hiring an advisor is something that can remove the obstacles to successful investing. The value can be very large.
As you can see by the slide below, the average investor over the past 20 years has averaged roughly 2.3% per year, largely due to behavioral errors. If one would have stuck with a moderate 60/40 portfolio instead, an investor would have had a 6.9% annualized return. To compare, $1 million would have turned into approximately $1,575,842 for the average investor over 20 years, but into $3,797,992 if only the investor could have stayed disciplined in a 60/40 portfolio. Remember, that includes the tech bubble of 2000 and the crash of 2008. Having an advisor help manage your behavioral biases, including the bias that losses are more painful to investors than gains are rewarding, will help you stay disciplined to your asset allocation when your “behavioral biases” are telling you it is a good time to get out of the market. It sure seems worth $2,222,150 over 20 years to do so!
To summarize, I think it makes sense to use evidence based dimensions of returns to structure a portfolio pursuant to the research of Eugene Fama, Thaler’s University of Chicago colleague and fellow Nobel laureate. (See Fama French 5 Factor Model). However, it is also very important to manage behavioral errors and biases of investors/clients per Professor Thaler and Kahneman’s research.
To read more about Thaler and his accomplishments, please see the following links.
US Economist Richard Thaler Wins Nobel Economics Prize
Richard Thaler wins Nobel Prize ‘for contributions to behavioural economics’
Nobel Prize Press Release – Integrating economics with psychology
New Advisor
I am excited to announce that my daughter, Emily, has joined McCartney Wealth Management as an Advisor. Emily was a Finance Major with a specialization in Entrepreneurship at the University of Alabama, graduating in the spring of 2015. After three consecutive internships throughout college with Mastercard’s Global Payroll department, she accepted a job at Mastercard on their Digital Payments Team in the summer of 2015. With a focus on data analytics and reporting Emily assisted Mastercard in bringing Digital Wallets such as Apple Pay, Android Pay and Samsung Pay to the US Market.
Emily transitioned to McCartney Wealth Management this past June and passed her Series 65 Certification in August. Emily’s role will consist of assisting and advising client needs and continuing our research and development initiatives while pursuing her Certified Financial Planner Certification. Emily takes our Fiduciary Role to heart and looks forward to putting you, the client, at the forefront of everything we do. Additionally, confidentiality has been deep rooted in all her past work experiences and you should find comfort that nothing leaves our office.
Outside of work Emily enjoys training for half marathons, spending time with family and friends, and cheering on the Crimson Tide.
Please do not hesitate to reach out to Emily for any of your needs. Her email is emily@mccwm.com and her direct dial is (314) 764-6488.
Additional Reading
Over a Quarter of Seniors Say Retirement Is Worse Than They Expected
What does being prepared for retirement mean to you?
Finance: How It Made Civilization Possible
Until next time,
Mike