What To Do After Incurring Losses?
Guest Article by Pavel Darahakupets
It is my pleasure to introduce a new guest author of the Gutmann Viewpoint newsletter this week: Pavel Darahakupets, CFA . Pavel is a portfolio manager with an emphasis on multi-asset management in the Chief Investment Office at Bank Gutmann. Prior to joining Gutmann in 2021, he was responsible for asset management focusing on institutional clients and quantitative analysis.
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What To Do After Incurring Losses?
Imagine a game involving a single toss of a fair coin: if you correctly guess the result, you win 200 US dollars. Otherwise, you lose 100 US dollars. Would you play such a game?
Almost 60 years ago, the Nobel Prize winner in economics Paul Samuelson offered this bet to his colleagues at the Massachusetts Institute of Technology (adjusted for inflation, today this would correspond to about 1,928 US dollars and 964 US dollars* respectively). Many have declined the experiment if it would only take place once. [1]
Fear feels stronger than Joy
Indeed, most people prefer to avoid this bet even if the expected return is in their favour. The reason is that our fear of loss is much stronger than the joy of potential gains.
Panic selling due to extreme sensitivity to short-term losses, which is an example of the so-called myopic loss aversion
Scientific studies provide evidence that investors who receive less frequent information
Returns through patience
Even if history does not necessarily repeat itself, there are important lessons to be learned from past experiences. One of these is a tendency of diversified portfolios to rebound
Illustrative example
The historical development of the global equity market performance over the last 4 decades** serves an example for the benefit of patience. The longer one has been waiting after a correction, the higher were the odds of positive returns.??
Source: MSCI Data, own calculations**
Past Performance is not indicative of future results.
Furthermore, the more time that passed since the pullback in the index, the higher the median return was. It can be observed that after one month following both 10% and 15% corrections in the index, the median returns had been in negative territory. After that, the situation improves steadily.
Comparing the median returns after 6 and 12 months since the drop in the market, one can see that they have more than doubled.?
Source: MSCI Data, own calculations**
Past Performance is not indicative of future results.
Perseverance pays off
An important condition however was not capitulating as it could mean missing out a period of a sharp rebound, which might turn out to be swift and represented only by a few “rally” days.
In our calculation example, if one has not been invested on the 30 best days since 1980, the annual return would see its value trimmed from 9.55% to 5.88% p.a. for the entire period. Moreover, considering that more than 20 out of these 30 best days occurred during the periods of prolonged market declines (2002/2003, 2008/2009, 2020), the result of not being invested in turbulent times becomes even more apparent.
Source: MSCI Data, own calculations**
Past Performance is not indicative of future results.
Time, not timing
Therefore, on par with an appropriate strategy, risk assessment and portfolio diversification, a very important consideration for long-term investors should be the time to allow their assets to grow, rather than attempts to time the market.
The tactic of outright cutting one’s positions and hoping to re-enter at a more favorable time may indicate an emotional decision-making process
Your portfolio. Your path.
Being too conservative based solely on recent market events represents a direct consequence of such a behavior and might hinder the ability to achieve your long-term financial goals
We, at Bank Gutmann, stand by your side even in challenging times. We are committed to developing a suitable portfolio strategy for you, taking into account your goals, your risk tolerance and your personal circumstances.
Talk to your client advisor about it. Discuss different options and find your own individual financial path.
[1] Samuelson P. (1963) Risk and Uncertainty: A Fallacy of Large Numbers. Scientia Vol. 98, N4, S.108-113.
[2] Larson, F., List, J. A., & Metcalfe, R. D. (2016). Can myopic loss aversion explain the equity premium puzzle? Evidence from a natural field experiment with professional traders. NBER Working Paper.
* based on seasonally adjusted quarterly consumer price index. Data from Q3 1963 to Q3 2022. Source: FactSet
** Estimations are based on daily data of MSCI World Net Return Equity Index, converted to Euro. Data from 31.12.1979 to 31.10.2022. Source: Bloomberg, Bank Gutmann.
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This is a marketing communication. Investments in financial instruments are exposed to market risks. Past performance does not predict future returns. Forecasts are not a reliable indicator of future performance. Tax treatment depends on each client's personal circumstances and may change in the future. Bank Gutmann AG hereby explicitly points out that this document is intended solely for personal use and for information only. Publishing, copying or transfer shall not be permitted without the consent of Bank Gutmann AG. The contents of this document have not been designed to meet the specific requirements of individual investors (desired return, tax situation, risk tolerance, etc.) but are of a general nature and reflect the current knowledge of the persons responsible for compiling the materials at the copy deadline. This document does not constitute an offer to buy or sell or a solicitation of an offer to buy or sell securities.
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