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The Default Setting

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Portfolio Manager
Wealth Advisory Services, Cincinnati

A few weeks ago, my wife surprised me on my birthday with a brand new iWatch. This was a big deal for her since she is not a huge fan of Apple products.  But she loves me and recognizes that I am.  As I opened the neatly appointed packaging, put it on my wrist, and synced it to my phone, I was pleasantly surprised by the ease of use right off the bat.  Part of that ease was because I didn’t have to make a bunch of tweaks and adjustments. I liked it just fine out of the box.  The default setting was good enough.

This got me thinking about a famous speech by David Foster Wallace, “This is Water.” For those who haven’t heard it, I encourage you to spend the 20 minutes to listen.  In this speech, Wallace talks about how we all have a natural default setting, but always have the ability to choose to think.  So, if this is true, why do we thrive as a species, but often falter so spectacularly in the face of adversity in the financial markets?  What are the aspects of the investor default setting that tend to do more harm than good in events like the market crash of 1987, the tech boom and bust, and the great recession?  Let’s choose to think about a couple:

Loss Aversion

If you should ever happen to find yourself roaming around the jungle and have even the slightest inkling you are being stalked by a pride of lions, you should, without question, turn and run the other way. Every time.  Even if it turns out to be a figment of your imagination.  This is as solid of advice as anyone can give you. And that is how our brains are naturally wired to think and act.  We wouldn’t have survived as a species without this natural default setting. 

However, the types of decisions that are made in the jungle are disastrous on Wall Street. As investors, we tend to suffer more pain and discomfort when we experience our investments going down in value than the pleasure we feel when they go up.  In fact, we feel twice as much pain on the downside than joy on the upside.  Just think about how you felt going through the great recession of 2008 or, more recently, the beginning of 2016.  Unfortunately, being aware of this default setting doesn’t allow us to turn it off.  We will all feel the pain, eventually.  However, putting measures in place, like adhering to a long-term strategic asset allocation, will help us fight those urges to turn and run.  Oh, and it won’t hurt to work with a master jungle guide.

Illusion of Control

I hope some of you can relate to my experience with flying: although I know better, my heart races every time the plane I am in hits the slightest bit of turbulence.  The probability that I perish in a fiery plane crash is extremely low. I know, I have looked it up many times!  Almost nil.  However, I have no problem tearing down the freeway with a little bit of a lead foot (ok, I go slower when the kids are in the car). The illusion of control I have being behind the steering wheel has a strong effect on my psyche. But the reality is that my odds of making it to my next destination in a car are much lower than in the sky.  

When it comes to investing, this illusion of control can do much more damage than a racing heart or a $100 speeding ticket. The markets have a long history of showing us how little of a corner on truth we have.  The moment you “know” something about a perfect stock pick or a great real estate opportunity is the time you need to go out and find that trusted person sitting in the passenger seat. 

As investors, it’s always helpful to know our natural default setting. Success comes a little bit easier when you choose to think, work to know yourself, and find ways to temper the forces that are working against you.  We are here as your trusted “jungle guide” to help you do that on your way to making good financial decisions.  It’s simple in theory, but certainly not in practice!

 

Dan Barnett is a Portfolio Manager with Johnson Investment Counsel (“Johnson”).

The views and opinions presented in this article are intended for entertainment and educational purposes only and should not be construed as a solicitation to effect transactions in securities or the rendering of personalized investment advice.  The views and opinions expressed in this article are not intended to be tailored financial advice and may not be suitable for your situation. No person should assume that any advice or strategies presented in this article serves as the receipt of, or a substitute for, personalized individual advice from an investment professional. You should consult with a professional before taking any action inspired by the views and opinions presented in this article.