Forecasting the future when it comes to investment markets sits within the “storytelling” realm. It is great to hear and read what the experts predict will happen next, but the evidence shows that these papers and reports should really be filed in the fiction section.
What SMSF investors can do is to be more aware of their investment biases, which if managed and minimised can save them a lot of money. Identifying behavioural challenges can stop you making an impulsive decision that could take years to correct.
History shows that over the long term the stock market averages a negative return once every four years. Investors often forget that what this means is that three out of four years are then on average providing positive returns.
For example, the US S&P 500 index is down about 20 per cent for the 2022 calendar year. However, consider previous returns of 29 per cent in 2021, 18 per cent in 2020 and 32 per cent in 2019. The average return for the US S&P 500 index over the past five years (including 2022) is still averaging a little over 10 per cent a year.
Why then do investors panic when that negative year hits? The reason that positive returns of previous years are often forgotten when markets fall is because most investors have what is called a “loss aversion” bias. Daniel Kahneman, the Nobel Prize winner known for his work on the psychology of judgement and decision-making, noted that investors tend to experience twice the amount of psychological pain from losses compared with the psychological pleasure from gains.
Essentially, this means that you feel the pain of losses in your portfolio much more than you enjoy the good years. In the good years you expect the market to deliver positive returns, but when markets fall you beat yourself up and convince yourself that you should have seen this coming and done something to mitigate the (paper) loss.
This then leads to the next bias when markets are falling and that is an action bias. This means that investors believe that taking action will improve their overall investment return.
When markets are falling, this becomes more pronounced because coupled with a loss aversion bias, investors feel compelled to act to stop “the pain”. Whether this action is trading in and out of asset class positions or cashing out completely, the evidence is clear – in almost all cases – that reacting to falling markets by taking such actions will not result in higher investment returns. The “do nothing” advice in times of volatility should be seen as a positive action based on the information and evidence, rather than a negative action by someone who can’t forecast the future.
Superannuation by implication is a long-term game. What we do know is that investment markets provide great returns for long-term and patient investors. By getting out of the way of the market and being alive to the inherent investment biases that we all face, you will give yourself the best chance to enjoy those positive years and rationally interpret the negative years.