How to make bear market experience less unpleasant
Posted September 8, 2008on:
“Ignorance is bliss” – American proverb
In 2002, Daniel Kahneman, an Israeli-American, won the Nobel Prize in Economics for his ground-breaking work in behavioral finance. During last prolonged bear market, the Israeli Pension Authority came to him with an all too common problem. Pensioners kept changing their investment allocations according to prevailing market conditions. These frequent changes not only were unhelpful for the long term, but also added costs to pension management. Kahneman gave them one simple solution: send the pensioners statements quarterly instead of monthly.
How can it help to know less about your investment performance?
I studied all seven bear markets since 1970 and calculated their peak-to-trough drawdowns (a reduction in account equity) from the perspective of four different types of investors:
- A: Investors who check their accounts intra-daily
- B: Investors who check their accounts monthly
- C: Investors who check their accounts quarterly
- D: Investors who check their accounts annually
Here are the results:
|S&P 500||Peak to trough drawdown|
|Peak date||Peak||Trough date||Trough||A||B||C||D|
Two observations emerge from this study:
- Regardless of the cyclic nature of bull and bear markets, the S&P 500 index keeps marching upward. (You don’t want to stop that march!)
- The more frequently you check your accounts, the more painfully you feel (and probably will react to) a bear market.
Take the bear market in 1987 for example; the intra-day peak-to-trough drawdown was 35%. For type C investors who checked their accounts quarterly, the drawdown was only 23%. Type D investors who checked their accounts annually would not feel the pain at all since the bear market began and ended within the year. Who would be more likely to stay the course? Go figure!