When Markets Are Tough, Don't Look

When market volatility ticks up, investors may be best served by tuning out

Ben Johnson 24.01.2019
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After an unusually placid 2017, markets have been in tumult. The pain has been pervasive. In 2018, 79% of Morningstar’s 105 U.S. fund categories had negative returns. This was the highest percentage since 2008.

Here, I will revisit one of the seminal works from the field of behavioral finance, which explores how investors respond to and demand to be compensated for risk. I will also share my thoughts on one way we might be able to better cope with market environments like the one we are experiencing today.

Nearsightedness
In their paper “Myopic Loss Aversion and the Equity Premium Puzzle,” [1] Shlomo Benartzi and Richard Thaler introduced a concept they called myopic loss aversion. Myopic loss aversion is an attempt to marry two pre-existing lines of research. The first of these is the equity premium puzzle. [2] We know that over very long periods stocks have outperformed bonds—by a lot. According to data from Ibbotson SBBI, a dollar invested in U.S. large-cap stocks in 1926 would have grown to $7,353 by the end of 2017. If you invested that same dollar in Treasury bills, it would have become $21. Stocks should offer higher returns than bonds because they are riskier, but the magnitude of this outperformance is puzzling.

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About Author

Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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