Time Bandits is a very entertaining 1981 fantasy movie by Terry Gilliam about bandits who use wormholes to travel back in time and plunder treasure…a cute movie to spend a few hours watching while you are locked down in this COVID misery.
In the context of investing and financial/retirement planning, Time Bandits speaks to how time is central to affecting every facet of our financial/retirement plan and investment experience. Time at this moment and how we feel about our world (see extrapolation below), time until we reach our wealth accumulation or retirement goal (see planning fallacy below). As humans we are always driven by time and at risk to let our biases (yes…you have them… I have them…we all have them) affect our decision making and analysis. Some biases are more prevalent and more critical to face and understand in times like this…COVID fears driving the market and economy down.
The first bias is extrapolation, our tendency to become overly focused on present trends and believing that they will continue to accelerate and be unending. We see this with the immediate 30%+ drawdown in the market early in the COVID pandemic, and the folly in it with the market having already made a substantial recovery since then. Investors chasing market trends, instead of staying the course and being fully invested, is one facet of extrapolation and is destructive to wealth accumulation. As an example, market inflows and outflows represent investors chasing a trend, and is often a negative indicator for market moves. In this example, as investors are selling, it may be an opportune time to be a buyer. Extrapolation draws investors into current trends and creates a frame work of short-term thinking, which is driven by emotions…fear, regret, despair…these are not the proper tools for the rational thinking investment decisions need. This bias may be one of the single greatest destroyer of investor returns.
The next bias is the planning fallacy. The tendency is to underestimate the amount of time needed to successfully achieve long-term financial goals. Investors focus on their “all-time high” (another bias called “anchoring”) which generates positive emotions as their investments reach new highs… and fear, regret, and impulsive overreactions when their wealth retreats from the all-time high. Wealth accumulation is a jagged ascent, not a smooth linear ascent. These inevitable pullbacks can lead to poor, emotion driven decisions if investors fall victim to their biases.
These biases and their attendant emotions can be mitigated with knowledge and understanding. We use multiple software tools to assess clients’ sensitivity to investment risk and model investment outcomes. Research and experience demonstrate that clients fair better when they have seen the potential range of outcomes both as to the positive and negative.
The range of returns a client experiences is very much driven by the points in time selected. As an example, measuring the S&P 500 from 2000-2018 shows a compound annual growth rate (CAGR) of 4.75%. If we move it just two years, 2002-2018, the CAGR is 6.71%. Moving it further to 2009-2018, the CAGR is 12.97%. To give our modeled returns as much clarity as possible, we use over 50 years of data and rolling three-year return periods to understand how an investor’s entry point in the measured period affects their potential returns.
If you are feeling overwhelmed by the recent market volatility, take advantage of the expensive tools we pay for and let us help you with a plan.
Our best wishes you stay safe and healthy,
Dave & Drew