Paul Meloan – Vested Interest

Many things that no one would ever think need instructions come with them, like shampoo bottles. Shampoo needs instructions (‘Apply to scalp. Lather, rinse, repeat’) lest the unsuspecting purchaser apply it to their feet.

Other things in life are freely obtainable, highly complex, yet have no owner’s manual, no FAQ attached, and no obvious indications of what to do with them.  The best example of this is probably children.

Somewhere in between these extremes lie our investments.  They require some effort to obtain, but once we hold them, what exactly are we supposed to do with them?

This question is called whenever markets decide to enter some period of spastic activity, either to the upside or to the down. As I type, the US market is sitting about 12% off recent highs seen only a few months ago.  If you’ve been an investor for decades then such movements may not stir much reaction from you.  If, however, you are relatively new to the game such events may stir feelings of “OMG, what am I supposed to do now?”

The beauty (and the challenge) of being a “buy and hold” investor is not in the buying part, it’s in the holding.  A big part of my thinking on this site and in my professional life is that money is never an end in itself, it is a means to an end.  For the great majority of people that means that if owning stocks when they were going up made sense, owning them in a decline makes sense as well.  The trouble is that most people have a very hard time sitting quietly and doing nothing.

Several key aspects of human psychology make this particularly difficult.

Most successful people have had it drummed into their heads about 56,000 times by the age of 21 how important it is to be ‘proactive.’  The thought of sitting by and doing nothing as their investments lose value stirs cognitive dissonance and other stressors.

Recency bias is another pitfall. Humans seem to think that whatever has been happening in the previous 18 months is all that is ever going to happen.  The most recent bottom in the market came almost seven years ago (March, 2009) so times of extended decline are hard to remember. This can go on for years.  When the turn comes it’s a surprise that no one saw coming.  Compare that to things that change frequently, like the weather: just because it’s a frigid January morning it’s not hard to imagine come July that we will be back to bitching and moaning about the heat and humidity.

The final pitfall is hindsight bias.  What no one saw coming now appears obvious, after the fact of course.  Investors believe that they should have been able to see into the future and correct accordingly.  Of course, if someone knew the future of the market she would have unlimited ability to amass wealth (limited only by access to capital).  Since I have not seen many trillionaires walking around town (despite no shortage of persons desiring to become one) I will conclude this is impossible.

The question I always ask clients concerned by stock market drops invariably looks something like this: When do you (the investor) need the money?  The answer is almost invariably measured in decades, not years.  OK: do you (the investor) believe that in X decades from now stock prices will be higher or lower than they are today?  No one has ever answered lower.


Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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