Smoke and Mirrors?

Are points and percentages just “smoke and mirrors” or a matter of perspective?

“Dow Jones drops almost 500 points after major stock market declines in Europe & Asia."

- Reuters Oct. 23, 2018

When we see headlines illustrating “drops” in the market of hundreds of points, it's important to keep those figures in perspective.

The Dow Jones Industrial Average was created in 1896 by Charles Dow and Edward Jones. The index is comprised of 30 blue chip (high-quality) US stocks, in order to measure the strength or weakness of the entire stock market.

On March 12, 1956 the Dow closed at 500.24 (its first time above 500).

That means if you are 63 years old, a swing of 500 points today represents almost 100% of the entire market when you were born!

Times have changes since 1963. On July 15, 2019, the Dow closed at a 27,359 – a record high!

Although the size and value of the market has increased dramatically in the past six decades, our frame of reference for the amount of points gained or lost in a one-day session hasn’t changed as much.

Charter Oak believes there is value in re-framing the way we think about fluctuations by focusing on percentage, not points and always taking daily volatility with a grain of salt.

Remember, if an investor missed the 5 best days over the past 10 years, they may have lost 28% of their total return (Bloomberg LP Data).

The Dow Jones Industrial Average dropped more than 500 points just three times in the 20th century (the first being October 19, 1987). However, it has dropped 29 times in the 19 years of the 21st century.

On a percentage basis, recent declines of 500 points or more are relatively small compared with Black Monday in October 1987. Even a drop of 1,000 plus points in February 2018 didn’t measure up.

Clearly, the impact of points (either up or down) is dwindling as a percentage of the market.

If markets are good at one thing, it’s reminding investors that stock prices don’t simply go up, uninterrupted, forever.

Markets do drop. That’s an unavoidable part of investing. What matters is how you respond. Or, more to the point, how you don’t respond.

“Where we stand depends on where we sit."

- Miles Law

Anchoring bias happens when we’re unconsciously influenced by an outdated, unrelated or even irrelevant data point.

With markets making a new “all time high” in July, it’s perfectly normal to anchor our portfolio value to the figures on our last statement or most recent balance.

Anchoring to certain values is part of everyone’s DNA, but like all things it has pros and cons depending on how we use it. To help illustrate how an anchoring bias may play a role in your decisions, we’ll use the story below:

Your uncle passed (after leading a full abundant life), leaving you his favorite antique car. According to the paperwork and insurance documents, it’s worth about $40,000.

You are not interested in maintaining an antique and decide to sell it. You get an offer of $15,000 and reject it; you receive another offer for $20,000 and reject it as well. Both offers were far below its stated $40,000 value that you anchored to.

Let’s present two options with alternative outcomes: (1) seek new information by researching a new price to sell the car, or (2) hold out for an offer of $40,000.

Researching a new price to confirm the car’s $40,000 price tag is a smart choice. Finding a new reference point allows you to make an informed financial decision. You will be able to sell the car for a fair price that you and the buyer are comfortable with.

Waiting for a $40,000 offer is a natural desire. In this mindset you want a buyer to match your original target, the first numeric value you learned of and are thereafter anchored to.

We all need a reference point, or anchor, for making financial decisions, and at times it can be useful. However, the negative effect of the bias comes in when we choose the wrong anchor.

Anchoring bias can also influence other financial planning decisions. Remember “the Joneses”? If your friends retire at a certain age, that could influence your own estimate about when you should retire, even though your circumstances are completely different from theirs.

One way to evaluate financial decisions with clarity is to find the most accurate anchors for a financial choice. Good anchors have solid sources and information that can be applied to your own circumstances and readjusted as the landscape changes.

Advisors at Charter Oak strive to provide our clients with clarity and perspective to make informed decisions that benefit themselves and their families with positive financial outcomes.

We do this through continuous education in ongoing conversations with clients about their investments, financial plans and behavioral empowerment.