“If everyone is thinking alike, then somebody isn’t thinking.”
~ General George S. Patton
The heard is often wrong.
As the name indicates, Herding Behavior is a phenomenon observed in the animal kingdom. Schools of fish, giant herds of antelope and elephants demonstrate this behavior – acting in unison, as if choreographed, moving from water hole to water hole, from food source to food source, and huddling together as a protection mechanism from poaching predators. It is our nature.
In human society, we can see Herding Behavior in many situations. Crowded restaurants draw more crowds, even if the food is mediocre. In emergency situations, people tend to use those exit routes that most other people are using. In investments, we see people selling and buying in distinctive patterns – buying what is the “talk of the town” and selling when the market is moving down in a herd-like mentality. We like being with others!
This can help explain why the average investor returns 2.6% over the last 30 years. (1) People buy and sell at the wrong times – when others are doing the same thing. In times of volatility in the market, people have a tendency to sell as they see the market selling. Not wanting to loose money, fear creeps into the decision process. Fear can be promulgated by many forces, which we have written about in a prior blog, you can read more here. The opposite is just as true. People like to buy what is hot, what is in the media as doing the best – what is on TV. You can see this action in our post, “Comparing Yourself to Others. . . to the market”
To eliminate biases, I like to look at what the raw data says. If you had a crystal ball and could pinpoint exactly when to by and when to sell, and when. But lacking this, what would happen if you missed the 10 best days in the market and what would happen if you missed the 10 worst days?
In the last 20 years (from 1998 through 2017), if you missed the best 10 days of the market, returns were reduced by almost 50%. Read that again, slowly.
Graphically, if you invested $100,000 and looked at the annualized returns of the S&P500 from 1998 through 2017 and missed the 10, 20, 30, 40, 50 and 60 best days in the market here are the results. (2)
To put this in perspective, there are approximately 5022 days (excludes weekends and holidays) during this time frame. Missing 10 days (or 0.2%), drops your returns by 50%. Missing 0.6% (or 30) of the best days days, gives you a negative return for 20 years.
So far so good? Can you start to see the linkage of how herding mentality of selling and buying can yield a such a low annualized return?
What is also interesting, is the best days come near the worst. Below is a snapshot of the 4 month period in 2008, when the markets we in turmoil. Some of the best positive days were mixed in with negative days.
In our current environment, we see this happening as well. With the increased algorithmic trading, both selling and buying, you see wide swings in the movement of the markets. These swings can be independent of individual economic and fundamental results.
However, in stepping back and looking over an expanded time frame, earnings drive returns. As earnings rise, so do stock prices. Ryan Detrick, Senior Market Strategist for LPL put it very well in a blog post. “Let’s get one thing straight—no one can predict the 10 best or 10 worst days of the year. Although it would be fun to somehow do this, the exercise hammers home that for the average investor, being invested and not making a lot of short-term bets may be the best way to accumulate long-term wealth.” (3)
Our philosophy with investments is to focus on the longer term and what is the purpose of the investments. We feel this is more important and relevant. Short-term volatility is to be expected and analyzed for opportunities, but not to drive a knee-jerk heard-like reactions that dismantle years, and sometimes decades old, strategies.
If you are a client reading this and have questions on your particular portfolio and strategy, please give us a call to discuss in detail.
If you are not a client and have experienced this herding behavior and have been impacted by it and feel our approach may benefit you, please give us a call. We can help you asses if our approach may benefit your goals.
Sources & Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All investing involves risk including loss of principal. No strategy, including rebalancing and diversification, assures success or protects against loss.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results.
Past performance is not necessarily a reliable indicator for current and future performance.
1. 30-year returns from 1987 though 2016. Oppenheimer Compelling Wealth Management Conversations pg. 6.
2. Morningstar Direct as of 12-31-2017. For illustrative purposes only and is not intended as investment advice. The charts are hypothetical examples which are shown for illustrative purposes only and do not predict or depict the performance of any investment.
3. What happens if you miss the 10 worst days of the year? Oct 17, 2018 Blog post.