The Investment Scientist

Once a Decade Discount of Stock Prices!

Posted on: March 17, 2020

 

MW-DB025_balaci_20141208133245_ZQ.jpgBy the close of the market yesterday, the Dow was discounted by 32% from its peak just three weeks ago. This level of discount happens once a decade. The last two times were during the 2000 dotcom bubble burst and 2008 financial crisis. 

I have been busy rebalancing portfolios for myself and my clients. What is a rebalancing? Imagine a client has a target allocation of 60/40, that is, 60% in stocks and 40% in bonds. After the last round of discounts, the allocation becomes 45/55. To get back to the target, I must sell bonds worth 15% of the portfolio and use the money to buy stocks.

All investors set out to buy low and sell high, but when the market is giving them a 30% discount, most of them freak out and want to sell every stock instead. There are a few human judgement heuristics and biases at play here that were studied by Nobel Prize winner Daniel Kahneman, like representative bias, base rate neglect, availability bias, anchoring and framing heuristic. When I have time, I will write about those heuristics and biases.

Today I am gonna teach you one heuristic that will make you a better investor. Instead of seeing the stock market fall as a permanent loss of wealth (which it is not), try framing it as a temporary discount of asset prices. If you don’t take advantage of the discount, I am sorry, in a few months, it will be gone. And it will be another ten years before this level of discount happens again.

Schedule a 2nd opinion financial review, buy my wealth mgmt book on Amazon.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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