“Losses loom larger than corresponding gains.”
Amos Tversky
“People generally feel a stronger impulse to avoid losses than to acquire gains.”
Daniel Kahneman and Amos Tversky
“The combination of loss aversion and narrow framing is a costly curse. Individual investors can avoid that curse, achieving the emotional benefits of broad framing while also saving time and agony, by reducing the frequency with which they check how well their investments are doing. Closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains.”
Daniel Kahneman
Market Review
Below are the returns from the indices we track.
| Periodic Performance | ||||||
| By 09/2018; Default Currency: USD | ||||||
| YTD | 3 Months | 1 Year | 3 Years | 5 Years | 10 Years | |
| S&P 500 | 10.56 | 7.71 | 17.91 | 17.31 | 13.95 | 11.97 |
| Russell 2000 | 11.51 | 3.58 | 15.24 | 17.12 | 11.07 | 11.11 |
| Russell 2000 Value | 7.14 | 1.60 | 9.33 | 16.12 | 9.91 | 9.52 |
| MSCI World ex USA (net div) | -1.50 | 1.31 | 2.67 | 9.32 | 4.24 | 5.18 |
| MSCI World ex USA Small Cap (net div) | -2.28 | -0.85 | 3.42 | 12.23 | 7.07 | 9.04 |
| MSCI Emerging Markets (net div) | -7.68 | -1.09 | -0.81 | 12.36 | 3.61 | 5.40 |
| Bloomberg Barclays U.S. Treas Bd 1-5 | -0.23 | 0.05 | -0.64 | 0.26 | 0.69 | 1.59 |
| ICE BofAML 1-Year US Treas Note | 1.07 | 0.41 | 1.08 | 0.74 | 0.55 | 0.71 |
US markets led the way in returns for the 3d quarter, outperforming both non-US developed and emerging markets in the quarter. Value has continued to underperform growth in the US across large and small cap stocks, and small company stocks underperformed large in the US also. The reverse has occurred over longer periods of time in a statistically significant way, and we structure our portfolios to have a bit more value and small cap in our allocations.
Internationally, large cap value stocks underperformed large cap growth; however small cap value did outperform small cap growth during the quarter. Small cap stocks not including value underperformed large company stocks internationally in the quarter.
Interest rates increased in the US during the third quarter. The yield on the 5-year Treasury note rose 21 basis points (bps), ending at 2.94%. The yield on the 10-year Treasury note increased 20 bps to 3.05%. The 30-year Treasury bond yield rose 21 bps to 3.19%.
On the short end of the yield curve, the 1-month Treasury bill yield increased 35 bps to 2.12%, while the 1-year Treasury bill yield rose 26 bps to 2.59%. The 2-year Treasury note yield finished at 2.81% after an increase of 29 bps.
Rising rates impact our portfolios less than others because we use short term hiqh quality bond funds with shorter duration (effective length to maturity). All else being equal, shorter duration bonds decline less in principal value than longer duration bonds when interest rates rise. The primary purpose of us holding bonds in our portfolios is to reduce downside risk; not to seek return. We do this because of the research of Nobel Prize Winner James Tobin and his Separation Theorem. However, as rates do normalize, we do expect that returns for our fixed income over time will increase to more historical levels.
Loss Aversion
As a follow on to our last newsletter, I want to continue to discuss some of the behavioral biases of individuals and investors that prevent optimal decision making.
“Loss aversion” refers to people’s tendency to prefer avoiding losses rather than acquiring equivalent gains. In general, it is more painful to lose $100 in an investment than to gain the equivalent $100. Another way to think about it is that individuals make decisions in a way that allows them to avoid feeling emotional pain in the event of an adverse outcome. Nobel Prize Winner Danny Kahneman and his research partner Amos Tversky are credited with identifying this bias through academic research.
As Kahneman has noted, loss aversion can be costly, as it can prevent people from pursuing reasonable higher expected returns in the long-term because they are too concerned about short-term losses. Because markets are generally negative 48-49% of daily trading, Kahneman warns that “closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains.”
By taking a broader view and looking less, the odds of one staying in the market and reaping gains increases. As an example, based upon S&P 500 returns from 1926 through calendar year 2017, the following are the percent of positive outcomes one realizes over different time periods:
Returns – Percent of Periods Positive
Annual Returns 74%
Rolling 5 Year Annualized Returns 86%
Rolling 10 Year Annualized Returns 95%
Rolling 15 Year Annualized Returns 100%
This information should encourage investors to take a long-term view.
It does not mean that the annualized returns are always great. The lowest rolling 15 year annualized return was just 0.6% annualized starting in 1929 for the next 15 years. However, that was a unique time as 1929 was the start of the Great Depression. Since 1973, the lowest rolling 15 year annualized return was 4.2% for the period starting in 2000 and ending in 2014. That 15 year period included 2 really bad downturns; 2000-2003 and 2007-2009.
Expected returns are time varying, meaning they are not always the same at different times. For example, expected returns were most certainly greater in February of 2009 than they are today. However, long-term “expected” returns are always positive. Take the long view for a better investment experience as well as results.
Cybersecurity Awareness Month
October is National Cybersecurity Awareness Month and we’d like to reiterate to you our strong commitment to keeping your personal information and your assets safe. While we are continuously working with our service providers to ensure your assets and information are protected, you can also take action for protect yourself and help secure your information.
In the beginning of 2018, we engaged with Schwab’s consulting services and underwent a 58 point NIST Cyber Security assessment. This six month program took inventory of all MWM systems and enables us to have detailed frameworks and roadmaps to manage cybersecurity-related risks.
There are also precautions that you can take to protect yourself and your personal information.
- Ensure that double authentication is enabled across all your log-ins.
- Be aware of phishing emails, texts and phone calls and do not open/click links or attachments from unknown sources.
- Do not access banking apps or personal email accounts on public Wi-Fi networks, and be sure to use personal Wi-Fi hotspots or Virtual Private Networks (VPN).
These are just a few of many ways you can protect yourself and your information. Click here for a comprehensive checklist for preventing fraud.
In the event that you suspect a breach, call our office immediately and we will work with you to alert our/your custodian. You can also request our “How to Respond to a Data Breach” flyer for more information.
Some Other Interesting Links
Here is a very good 2 1/2 minute video on the importance of professional financial advice. Enjoy!
Until next time,
Mike and Emily