Jorge Padilla, CFP®
Principal, Senior Client Advisor
May 25, 2022

A few weeks ago, our team enjoyed an offsite meeting at a resort in Key Largo that included some fun activities to disconnect and also some focused work as a team. One of the particularities of the resort is their restrictive policy around cell phone usage in certain areas. On the way back, my wife and I started a dialogue about the impact the 24/7 connectivity that our smartphones and the internet are having in our lives. It was just a few decades ago that we were still consuming information at a slower pace, outside of the digital world. Are we better off as a society, as a result? Certainly, the ability to provide access to information and knowledge to a wider audience will generally lead to progress. At the same time, are we happier than older generations in this hyper-connected world? I will let you answer that question for yourself.

We Are What We Consume
One thing is clear, our brains did not evolve over thousands of years to cope with the constant stimulation that our current 24/7 news and notification cycle presents. Similar to how our bodies become a reflection of what we eat, our minds may become a reflection of what we think. Just like we care about our nutritional diet, we should start thinking about being purposeful with our informational diet. Whether we realize it or not, with every notification, idea, or news story we consume, there are subconscious processes in our brain trying to decide if we need to act or do something with it. As it relates to making money and investing decisions, the abundance of stimulation and information seems to lead to a higher probability of overreacting and making poor investment decisions. You may be feeling uncomfortable now and feeling like you (or we) need to do something because you are seeing the market value of your investment portfolio dropping!

Investors Took a Billion-Dollar Bath Trading Options During the Pandemic
Unfortunately, the pandemic created social experiments on many levels. One experiment I have followed closely has been how investors have behaved during a period of free money (i.e., stimulus checks) and extra time to trade. A recent article by Bloomberg covers a study completed by the London Business School that found retail investors lost more than $1 billion trading options between November 2019 and June 2021. Not only that, they also estimate that the ‘hidden’ trading costs of trading options may have added an additional $4 billion in costs. Online trading platforms spend a lot of time and money to make their trading applications as easy to use and addictive as possible, and eliminating explicit trading costs from the investor’s view is one of the best ways to incentivize trading. Have you wondered why they want users to trade more? You guessed it, the more you trade for “free”, the more money they make. Unfortunately, this is another example of how our brain is not naturally wired to process the overstimulation and ends up overreacting, causing more harm than good.

The New Social Media-Driven Retail Trading Frenzy
Yet another example of how retail investors may be having a difficult time lately can be found by looking at the performance of Roundhill MEME ETF (an exchange traded fund), which is down nearly -50% year-to-date (to clarify, this is not a security we recommend in our portfolios). The new social media-driven retail trading frenzy became so popular during the pandemic with names like GameStop and AMC Entertainment that an investment firm decided to package it in an ETF. This fund makes clear in the investment objective that it will select stocks based on social media interest or other measures of market sentiment. This is probably no different than what many retail investors were doing while, at the same time, ignoring fundamental and/or financial metrics. While we try to keep an open mind for everything, we have a hard time thinking that this approach would be more superior over time than investment plan based upon the evidence of sound principles and fundamentals such as focusing on revenue growth, cash flow, earnings, dividends, etc.

The Behavior Gap
In the investment industry, the cost for overreacting and over trading is referred to as “The Behavior Gap” and it has been observed for decades. The most recent data from Dalbar, as captured by JPMorgan's Guide to the Markets, shows the 20-year annualized return for the average investor was 3.6%. This is less than investing in bonds (4.3%) and about a third of what the S&P 500 earned (9.5%). Similarly, there have been numerous studies that show the value of a good advisor to be anywhere from 1%-3% over time (see Vanguard Advisor Alpha studies), and a good portion of this comes from the behavioral coaching aspects associated with eliminating the Behavior Gap.

Why is this Behavior Gap relevant now? Because we are living through rapidly changing times, with serious issues at different levels: growing inequality in income between the rich and middle class and poor, and a 24/7 news cycle that is designed to augment the importance of everything so there are more viewers, clicks, trades—or else. No, we are not downplaying the severity of the ongoing conflict in Eastern Europe, which will redefine geopolitics for years to come; or, dismissing the impact of a 40-year high in US inflation and the ramifications it has for stock and bond prices moving forward. Certainly, there are more ongoing concerns that we are watching and assessing (on an ongoing basis) to determine whether, or not, we should be adjusting areas of the portfolios. In most cases, we find that our portfolios are already well diversified, as we have tried to incorporate different strategies that do well in different economic environments.

Rising Interest Rates
For example, one major concern is that the Federal Reserve Bank (FED) is raising interest rates and that bonds will drop in value. While the FED has only raised rates by 0.75% so far, the bond market has probably priced in all the rate increases the FED is expected to do. This has resulted in the worst 5-month bond performance ever. So, reacting and selling bonds now would not be a wise thing to do.

Furthermore, newly issued bonds will now have a higher interest rate, which will increase returns moving forward. While our bond portfolios have not been immune to the decline, we adjusted our bond strategies in 2016-2017 to be have shorter maturities, a more flexible approach, and to incorporate non-traditional lending. The timing may have been early but the results now are making a difference and our bond portfolios have declined about 25% less than the overall US bond market as measured by the U.S. Aggregate Bond Index.

Is a Recession on the Horizon?
Another major concern is whether we are going into a recession and the impact it could have on stock portfolios. In all of the reading and listening that we do to investment strategists and economists, we find that there are very mixed views and great arguments on both sides about whether the US might enter a recession this year. Are the odds of a recession greater now than they were in January 2022? Certainly. At this time, the market has already priced those odds, and the S&P 500 is down about 16%, the NASDAQ 24%, and the Russell 2000 (US small companies index) down 20%. And, as of May 13th, 2022, the S&P 500 index has had six consecutive negative weeks since its inception. In that same time frame, there have been only 4 times when—following a six-consecutive-negative-week run—the following 12-month S&P 500 return was less than -5% and 9 times when the following 12-month return was positive.


Just as we could see a continuing decline in stocks, we could also see positive returns—driven by a continuation of the US consumer’s desire to buy products and services—which will continue to provide company profits, and drive stock prices higher. Nevertheless, given the uncertainty and volatility ahead, we remain invested in defensive (or hedged) stock strategies that we incorporated in 2020 in the majority of client portfolios. These strategies are reducing the downside volatility across all stock portfolios this year. We also maintain some “value” style (lower priced, higher dividend-paying companies) in the portfolios, which has held up better than “growth” style of companies. In addition, we have 20% allocated across real estate, infrastructure, and alternative strategies, many of which are outperforming significantly both stocks and bonds this year.


Client Portfolio Highlights
Here are some highlights of where we have focused our efforts over the past few months:

Ultimately, your financial needs and goals are what drive all the thinking and investment analysis behind the diversified portfolios we create for you. In our investment journey together, there will be periods where the markets will test your comfort level with the risk needed to meet your goals. If this is one of those periods where the changes in the value of your investments are making you lose sleep at night, please reach out to us to have a conversation.

If this is a moment when the 24/7 news cycle is upsetting you and you have concerns about the value of your portfolio, we'd welcome the opportunity for a discussion about how your information and content diet may be translating into impact on your portfolio. Please feel free to extend this invitation to any friend or family member who may benefit from having this conversation.

While the markets and economy may remain volatile ahead, we remain disciplined in our investment approach and committed to your financial goals. We thank you for the opportunity to be part of your financial life.

Linda Lubitz Boone, CFP®
October 18, 2023
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