How I learned to stop worrying and love the bomb
Paraphrasing Dr Strangelove to chill in retirement
by Doug Brodie
Do you read the FT?
Most readers here will say ‘no’, and that’s as it should be. In the main, the FT is not written for you, so the content and articles are not designed to guide and inform you.
The FT readership numbers are the same in both the US and the UK, so if you were to look at the comments from readers it’s quite likely they are written in New York, or Houston. The FT has more readers in Europe/Asia and Australasia than in the UK, so the journalists are addressing more readers in developing nations than developed.
It’s useful to know the demographic of your news sources because, like ice cream, there’s lots of different flavours of the same thing.
The FT leads today with a story about big traders ‘plunging into options bets’ on US equity prices within just a day. Let me simplify what this actually is, for you and me: an option is simply a right to buy something at a specified price, within a specified time period. You buy the option and if the price you specified comes up, you win, if it doesn’t, then that option just expires.
Trading options is just betting: at 14.05 today at Aintree, Ashtown Lad is running in the 11.45 Becher Handicap Chase. You can buy an option on him winning, Ladbrokes will give you 12/1 on your investment. If he doesn’t win, you get nothing. Buying options on the S&P 500 is the same thing, a bet. Now I know some do, but if you don’t regard betting as a way of making money you won’t be reading the Racing Post – and you probably shouldn’t read the FT either (though the FT Weekend is a lovely paper!).
Anyway, onto this week’s blog…
Tell the kids – house prices fell more than expected in November, Nationwide tells us we lost 1.4% following a fall of 0.9% in October. Good for those buying, not so good for the sellers (and for every buyer there’s also a seller), and totally irrelevant for those using houses as our homes to live in.
But who flips houses on a monthly basis? These are not S&P traded options, these are peoples’ homes and there is a fundamental difference in valuations.
In New York alone the S&P daily option is continuously valued, bought, sold and traded every second of the 6.5 trading hours, so that would be 23,400 times per day. Your house is probably valued once every 5?, 10? years? The value of the home is irrelevant today, it is the shelter, the refuge, the office, the storage, the canteen, the utility functions of your daily living. At the age we all are, we don’t worry about short term fluctuations of or homes – and we look to do exactly the same with pensions and income portfolios.
This is how the erudite Simon Evan-Cook distills the message – he compares the volatility of three options:-
They are all showing the 2020 performance of the global stock market, but simply looking at values at different time periods – weekly on the left, to yearly on the right. The returns are the same, the anxiety is very different!
This is crucial, and so much so that the jolly academician Richard Thaler was awarded the Nobel Prize for his work in this area – about the understanding of how you and I react and behave. This is how he explains the errors you and I make when we see volatility:
Here’s Countin’ Your Money While Sittin’ at the Table
Vince is a stockbroker, and he has constant access to information about the value of all of his investments. By habit, at the end of each day, he runs a little program to calculate how much money he has made or lost that day. Being Human, when Vince loses five thousand dollars in a day he is miserable— about as miserable as he is happy at the end of a day when he gains ten thousand dollars. How does Vince feel about investing in stocks? Very nervous! On a daily basis, stocks go down almost as often as they go up, so if you are feeling the pain of losses much more acutely than the pleasure of gains, you will hate investing in stocks.
Now compare Vince with his friend and client Rip, a scion of the old Van Winkle family. In a visit to his doctor Rip is told that he is about to follow the long-standing family tradition and will soon go to sleep for twenty years. The doctor tells him to make sure he has a comfortable bed, and suggests that Rip call his broker to make sure his asset allocation is where it should be. How will Rip feel about investing in stocks? Quite calm! Over a twenty-year period, stocks are almost certain to go up. (There is no twenty-year period in history in which stocks have declined in real value, or have been outperformed by bonds.) So Rip calls Vince, tells him to put all his money in stocks, and sleeps like a baby.
The lesson from the story of Vince and Rip is that attitudes toward risk depend on the frequency with which investors monitor their portfolios. As Kenny Rogers advises in his famous song “The Gambler”: “You never count your money when you’re sittin’ at the table, /There’ll be time enough for countin’ when the dealin’s done.”
Many investors do not heed this good advice and invest too little of their money in stocks. We believe this qualifies as a mistake, because if the investors are shown the evidence on the risks of stocks and bonds over a long period of time, such as twenty years (the relevant horizon for many investors), they choose to invest nearly all of their money in stocks.
We agree. This is not just academic theory, we witnessed someone ‘implode’ in April 2020 shortly after the pandemic struck. As the market got more and more fragile his response was to check his values on his phone more and more frequently, eventually ding this twice a day and requesting valuations every morning. This was effectively a financial nervous breakdown which is both financially and emotionally very destructive. If you have a pension valuation app on your phone, please delete it, you’ll sleep better.