Entries by Dr. Erik Davidson, CFA

Our Own Worst Enemy – Seven Key Tactics for Preventing Investment Missteps

For what I want to do I do not do, but what I hate I do.

Romans 7:15

In my own Christian walk over the decades, one of the biggest challenges in my life has not necessarily been the issue of knowing the right thing to do, but rather actually doing that right thing which I already know! The Bible often references this disconnect between “knowing” and “doing.” In Matthew 26:41, we read the oft quoted “The spirit is willing, but the flesh is weak.” Similarly, Romans 7:15 insightfully notes “For what I want to do I do not do, but what I hate I do.”

This propensity to know the right thing to do, but to do otherwise manifests itself when investing as well. Our piece, Matters of the Heart, discusses the pitfalls of emotion-based investing. The relatively new field of Behavioral Finance is predicated on the thesis that investors make sub-optimal decisions due to a number of common psychological tendencies. These behavioral shortcomings cause investors to make imprudent investment decisions, oftentimes enthusiastically buying at high market levels and despondently selling at low market levels. Investors find themselves doing the exact opposite of what they know they should do…buy low and sell high. In other words, Behavioral Finance teaches us that even when investors know the right thing to do, they oftentimes do otherwise. Sounds like something we might read in the Bible, yes?!

Behavioral economist, Dr. Richard Thaler, winner of the Nobel Prize, refers to people who always make rational economic decisions as mythical “Econs,” who do not really exist in real life. Real, flesh and blood humans, Thaler contends, are subject to emotions, biases, heuristics, etc. which cause us to make decision-making errors that Econs would never make. Benjamin Graham, the legendary economist, investor, and professor (Warren Buffett was his student!), summed up the challenge well, “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

There are several key Behavioral Finance mistakes that investors make. With a) Loss Aversion, investors mistakenly overweight the pain of potential losses while underweighting the benefit of potential gains; b) Anchoring causes investors to cling to prior reference points, vainly longing for things to return to “normal” or to get back to “even,” while failing to adapt to changed market conditions; and c) Recency Bias, investors extrapolate the latest market direction, up or down, far into the future. While being finite does not mean being sinful, the limitations that behavioral finance identifies in all of us provides an opportunity for greed and fear to take advantage of our finite nature.

So, given that the Bible as well as the field of Behavioral Finance teaches us that, as humans, we are predisposed to do those things that we know that we should not do and to not do those things that we know that we should do, what measures can investors take to mitigate these behavioral errors, especially during these anxiety-provoking Pandemic times?

  1. Make a Written Plan – In our piece, What’s The Purpose?, we discussed the importance of an investor first determining the specific financial goal(s) in order to achieve a successful investment outcome. To increase the probability of achieving those financial goals, experts agree that having a specific, written plan to accomplish that goal(s) is critical. Then, referring back to that written document on a regular basis (e.g. quarterly), affords investors a helpful, consistent reminder to counter fluctuating emotions in the midst of market moves.
  2. Hire an Advisor – Certainly, hiring a financial advisor provides very important knowledge and expertise for investors. However, even beyond that, a financial advisor can serve as an important “personal trainer” that helps investors overcome bad habits and poor decisions. Also, an advisor can be an “accountability partner” to whom one must explain a significant financial decision before taking action. This can help keep investors from being swept up in market bubbles or panics.
  3. Automate – Investors should seek to systemize their investment activities as much as possible so that emotions do not affect their investment decisions. Automatic contributions to a retirement plan from one’s regular paycheck is a good example of a way to overcome behavioral finance weaknesses. Dollar Cost Averaging (DCA) is a systematic way to take emotions out of play by deploying a given dollar amount into investments on a predetermined schedule. Dollar Cost Withdrawals (DCW) does similarly for taking money out of investments. Likewise, a set rebalancing plan (calendar or percentage based) is an unemotional way to trim back investments at relative highs and redeploy the proceeds into other investments near relative lows.
  4. Employ Values-Based Investing – When investors see their investments as not only a means to achieving financial goals, but also goals of a “higher calling” (e.g. Biblically Responsible Investing), they are less likely to get caught up in bouts of market euphoria or despondency. When investors view their investments as “dual-purpose,” they are more likely to maintain a longer term perspective in the midst of gyrating emotions.
  5. “Bucket” Investments – The Behavioral Finance concept of “mental accounting” describes the financial mistakes people make by categorizing money into differing accounts and not considering wealth implications holistically when making decisions. This tendency, however, can also be used advantageously in the investor’s continuing fight against fear and greed. By separating investments into two categories of 1) “preserve wealth” (lower risk, lower return investments) and 2) “grow wealth” (higher risk, higher return investments), investors are more likely to maintain a long term investment strategy, even in the face of feelings brought on by market volatility. In Bear Market To Do List, we discussed the importance of having 6 to 24 months of living expenses held in safe, low-yielding cash, savings, or money market accounts in order to weather short-term market turbulence.
  6.  Utilize “Insurance” – Employing a strategy of rolling, deep out-of-the-money put options on broad equity indices can function like an insurance policy to help shield investors against catastrophic investment losses. This empowers investors to pursue a more prudent long-term investment strategy. Like insurance, however, this peace of mind does come with a deductible (the amount the put option is “out-of-the-money”) as well as the on-going cost of the premiums that must be paid to maintain the protection.
  7. Reframe Time Periods – The typical investor’s financial goals are measured not in days, weeks, or months, but rather years, decades, and generations. Therefore, while it is nearly impossible in our present-day, always-connected world to drown out the noise of financial market news, investors are well-served to commit to reviewing their investment portfolio’s performance only on a scheduled basis (e.g. quarterly). Further, in order to mitigate impulsive decisions, past investment performance should be viewed as long term only (five years or more, if available) and on a cumulative basis rather than annualized.


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

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*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

The Weapons We Fight With

The weapons we fight with are not the weapons of the world. On the contrary, they have divine power to demolish strongholds.

2 Corinthians 10:4

Note – As we comment on the current economic and market environment, it is always with the full understanding that the Coronavirus Crisis is first and foremost a humanitarian one. Therefore, our hearts groan as we “weep with those who weep” (Romans 12:15), and we cling to the promise that “He heals the broken-hearted and binds up their wounds.” (Psalm 147:3)

With the abrupt end of the longest bull market in the history of the U.S. stock market, investors are now understandably worried about the probable depth and length of the current bear market in which we find ourselves. So, let’s take a look at this bear market in the context of the history of prior bear markets.

So far, the current stock market’s worst drawdown from its February 19 peak (S&P 500 close of 3386) was its March 23 nadir (S&P 500 close of 2237) for a loss of 33.9%. With the recent rebound, as of March 31 (S&P 500 close of 2585), the stock market is now down “only” 23.7%. While it is certainly possible that further downside awaits, our view is that the lows we have experienced are closer to the bottom than to the top. Here is our rationale:

Referring to history, the U.S. stock market has seen deeper bear markets than what we have seen so far with this downturn. The 2007 – 2009 Financial Crisis saw a decline of 56.8% in the S&P 500 and the 2000 – 2002 Technology Bust, exacerbated by the September 11 terrorist attack, recorded a 49.2% peak-to-trough loss. The 1973 – 1974 Oil Embargo Crash was 48.2% and the Great Crash of 1930 – 1932 saw a devastating loss of 82.8%. However, each of these more substantive stock market drops listed was preceded by periods of exuberant valuation bubbles in stocks themselves or in housing as seen in the Financial Crisis.

Though we had expressed concerns about the record length of the most recent bull market and economic expansions with valuations starting to show signs of excess (see Trouble), we were not of the view that equities had reached bubble territory. In our opinion, the cause for this current bear market was the exogenous event of the Coronavirus outbreak. Therefore, assuming that this shock will be addressed, it is probable that this stock slide will not be as dramatic as those listed above. As an example of the impact of an exogenous event, the heightened Cold War tensions preceding the Cuban Missile Crisis in 1961 – 1962 led to a drop in the S&P 500 of 28.0%. Moreover, even with the tragic loss of life and economic destruction of World War II, that exogenous event caused the S&P 500 to drop “only” by 42.3% during the 1939 – 1942 bear market.

The current crisis environment is increasingly being described as one of “wartime.” Given the potential fatalities, the disruptive impact to “normal” life, and the economic damage, this “battle” metaphor seems warranted. The Bible contains many stories of wars and battles and oftentimes employs combat imagery, including Ephesians 6’s reference to “putting on the full armor of God.”

Christians know from 2 Corinthians 10:4 that the weapons with which we are called to fight with are “not the weapons of the world.” Specifically, we are called to employ spiritual weapons which “have divine power to demolish strongholds.” During this time of anguish and loss, believers can be praying and fasting for the demolition of the Coronavirus stronghold.

Beyond those spiritual weapons, there are many other God-ordained “weapons” that are being brought to bear against the “invisible enemy” that humanity faces together. By themselves, none of these weapons are sufficient, but in combination they can prevail to the benefit of our collective physical and economic health.

Healthcare Weapons – Many of our family, friends, and neighbors are serving on the front lines of this war as doctors, nurses, etc. by delivering skilled and compassionate medical care to the sick and dying. These members of our communities are putting themselves in harm’s way for our safety. They should forever be remembered as heroes for their selfless service during this time.

Medical Science Weapons – Never underestimate the power of human ingenuity when brought to bear against what might appear to be insurmountable challenges. At this very moment, scientists, doctors, researchers, pharmaceutical firms, biotech companies, hospitals, medical device manufacturers, medical testing companies, and many others around the world are working around the clock to bring quickly to market the medical solutions needed to end this pandemic crisis.

Behavioral Weapons – By now, we are all too familiar with the concepts of “social distancing,” “shelter in place,” etc. While inconvenient and confining, these constraints are proving to be effective in curbing the transmission of the virus as well as “flattening the curve” to accommodate medical capacity constraints.

Monetary Weapons – The Federal Reserve Bank of the United States has taken its own wartime efforts to mitigate the inevitable economic damage of the Coronavirus. By pushing the overnight Federal Funds target rate to below ¼% and reinstituting Quantitative Easing with $4 Trillion of bond purchases, the Fed has loosened its monetary policy spigots wide open.

Fiscal Weapons – With last week’s signing of the Phase 3 $2.1 Trillion stimulus package, there is little doubt that the nation’s checkbook is open in the fight to save the economy. While a recession for the country has become almost a foregone conclusion, the battle lines are now being drawn with payments to households, loans to small businesses, etc., in an effort to keep the economy from entering a depression. Also, many regulatory red-tape constraints are rapidly being cut to free up companies to conduct business as needed to meet the marketplace needs.

This list of weapons, when used in combination, can give us confidence that we will prevail against the Coronavirus enemy. Lives will be saved, the economy will recover, and our collective “pursuit of happiness” continued. We will get through this!

So, while there is likely more turbulence yet to come in this epic battle against the unseen enemy, investors can take comfort at the multitude and strength of the “weapons” being brought to bear against it. As stewards of God’s financial capital, we should recognize our responsibility–in fact our “calling” (Luke 19 Parable of the Talents)–not to cower in fear but rather to look for opportunities to deploy capital prudently in this time of need. Getting practical, in Bear Market “To Do” List – P.E.A.C.E., we suggested Dollar Cost Averaging (DCA) as a strategy to ease cash into this turbulent stock market. Finally, as followers of Christ, let us pray together earnestly for that “divine power to demolish strongholds.”


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

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*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Bear Market “To Do” List – P.E.A.C.E.

Peace I leave with you; my peace I give to you. Not as the world gives do I give to you. Let not your hearts be troubled, neither let them be afraid.

John 14:27

As a follow-up to my piece, Troubles, a few weeks ago, I offer you some of my further thoughts on navigating the current market environment as a biblically responsible investor.

From an economic perspective, the Coronavirus pandemic is both a demand-shock and a supply-shock. So, as opposed to a significant hurricane or blizzard or even the 9/11 terrorist attack, this exogenous event may not simply push back economic activity, but rather may actually destroy it. Therefore, it is highly likely we have already entered a recession. Monetary and fiscal stimulus are critical components for an economic recovery. They must be done. However, in and of themselves, these economic policy levers are not enough. The new health concerns that have emerged must be addressed over the coming months, into the next flu season, and for years thereafter. Further, consumer and business confidence must be restored. This will simply take time and there are no short-cuts around it. Lastly, while we all long for a return to “normal,” it is likely that when we do emerge from this crisis (and we will!), life and the economy will be different than it was before. Specifically, our day-to-day lives and the economic environment will be changed in terms of travel, social interaction, entertainment, health care, the social safety net, politics, globalization, etc.

As we face these challenges, we must remember that it is buried very deep within our human nature to want to take action in the face of adversity. Especially in times like these, our natural behavioral instincts (incl. survival and herding) activate into high gear and we rally under the banner of “Don’t just sit there—do something!” Against that instinct, however, the Bible gives us the challenging guidance to “Be still, and know that I am God” (Psalm 46:10). It is almost as if our command as believers is counterintuitively to “Don’t just do something—sit there!”

In our hearts, we know that this is wise instruction, but it is a tough pill to swallow as the stock market plunges. Fortunately, most investment experts wisely support this concept of prudence by advocating a mindset of calmness, resolution, and perspective. However, many times their advice is offered as a “To Don’t List,” e.g., “Don’t panic!” “Don’t sell!” “Don’t abandon your plan!” “Don’t capitulate!” or “Don’t liquidate!” All these are wise guidelines, but they go against our very strong human reflex to actually do something!

Therefore, in contrast to a “To Don’t List,” I share with you a list of proactive actions that can be taken by investors right now. This is based on my 35 years of investment experience, but equally on my 45 years of being a follower of Jesus Christ. This Bear Market “To Do List” is called “P.E.A.C.E.”

P.E.A.C.E.

Pray: Before anything else, let’s be sure to pray. Let’s be on our knees crying out to God for healing, comfort, and provision for those who have been affected by the Coronavirus. Let’s pray and fast in support of the global forces of human ingenuity, science, and wisdom being brought to bear against this modern-day pestilence. Lastly, let’s pray that through this adversity, many will come into a personal relationship with God. Praying is something we can “do.”

Engage: Engagement is something that we can definitely do in this environment. Even if they are not afflicted by the Coronavirus, so many around us have been impacted adversely. Within the proper protocols of “social distancing,” let’s engage with our family, friends, and community who need our assistance—neighbors who need to be checked on, seniors who need some shopping done, or maybe some health-care or emergency-services workers who need help with their out-of-school children. Let’s look for ways to support local businesses and their employees who are suffering dramatic downturns in their revenues. How can we support those in our communities who are most economically vulnerable? Engage is something we all can “do.”

Assistance: Unfortunately, economic downturns often lead to a significant decline in charitable giving—just when the needs are at their greatest. Therefore, something that we can “do” is to maintain, if not even increase, our donations to our church, community organizations, medical-research charities, etc. They need it now more than ever. Assistance is something we all can “do.”

Cash: In all market environments, bull and bear, one essential thing that investors must “do” is ensure that they hold an adequate amount of cash. This cushion mitigates the risk of having to “sell into a hole” during a market downturn when money is needed to cover expenses. Most financial planning experts recommend that anywhere from 6 to 24 months of living expenses be held in safe, low-yielding cash, savings, or money market accounts. If an investor does not currently have that amount of money set aside, then now is the time to do it, even though the market has sold off so dramatically. However, even in such a volatile market environment, investors should be cautious about holding too much cash, especially with current interest rates so low. Remember that at 0.25% per year, an investor is on course to double her money in 288 years! Having the right amount of cash—not too little, but not too much—that is another thing that investors can “do” in this market environment.

Ease into the stock market: In these trying times, our “fight or flight” instincts are particularly pronounced. So while many investors are grappling with their “flight” impulses, others are engaging with their desire to “fight,” i.e., buy at these significantly depressed levels. Sometimes this is likened to trying to catch a falling knife. From our perspective, the stock market’s downside risk is still substantial. However, at -30% from the all-time high and with valuations much more attractive now, we believe that we are likely closer to the bottom than the top. Further, being a provider of investment capital in such dire times also meets a higher, noble purpose. Therefore, what investors can “do” if they have cash ready to be deployed is start easing into the market. A “dollar cost averaging” (DCA) strategy is a good method to minimize the emotional toils of a turbulent market by committing to invest a set dollar amount on a predetermined schedule, come what may. For those investors who are already fully invested, there is still something that they can “do,” namely rebalance. In rebalancing, investors make adjustments to their portfolio at the margin to bring it back to its target percentage allocations. In other words, trimming down (not selling out completely) some of those investments in asset categories that have done relatively well (e.g., bonds) and redeploying the proceeds into asset categories that have done relatively poorly (e.g., stocks). These are some prudent things that investors can “do” to ease into the stock market in the face of the sell-off.

In conclusion, I urge you to keep the faith as you grapple with your “To Don’t” and “To Do” lists under these stressful conditions. It affects all of us! Even Paul wrote, “For what I want to do I do not do, but what I hate I do” (Romans 7:15)!

And when grip of fear tightens, just remember the promise we have received:

Come to me, all who labor and are heavy laden, and I will give you rest. Take my yoke upon you, and learn from me, for I am gentle and lowly in heart, and you will find rest for your souls.

Matthew 11:28-29


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

LinkedIn

*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Trouble

“In this world you will have trouble. But take heart! I have overcome the world.”

John 16:33

While the Bible does not speak specifically about Coronavirus outbreaks or stock market plunges, it certainly does speak about plagues and pestilence, as well as periods of adversity and trouble. So, with that in mind here are some thoughts on the recent stock market sell-off from the vantage points of investment history, behavioral finance, and biblical wisdom.

In my many decades of investment experience, I have seen my fair share of market turbulence and even many “crashes”. During my career, there have been all matter of reasons to spark stock market sell-offs, however, this is the first time in my experience that a pandemic scare has been the catalyst for a significant stock market plunge. Yes, in the past, investors have expressed worries about health-related issues (Ebola, SARS, etc.), but nothing medical that I can remember has had the sort of impact that we are currently seeing. Not being a medical expert (although I am a “doctor”!), from my limited perspective, it seems that the pandemic concerns have legitimacy and therefore the potential to cause significant human and economic damage. While we may have some feelings of despair in the face of this challenge, as Christians, we can pray with confidence to God that the coordinated global forces of human ingenuity being brought to bear on this calamity will prevail. Even with that envisioned success, however, going forward, this new type of risk, global health, will now be a top-of-mind concern for investors for years to come.

While, most importantly, caring for and praying for those who have been afflicted (“Weeping with those who weep” – Romans 12:15), prudent investors nevertheless do need to consider the market implications of this medical emergency.  Stock market corrections (generally viewed by investors as the S&P 500 being down -10% from the prior high) are very common, coming on average every 11 months. Bear markets (generally viewed by investors as the S&P 500 being down -20% from the prior high) are less frequent, but still have visited investors on average every 44 months. With that context, it is important to remember that this 11-year bull market has been the longest in the history of the US stock market. That combined with recent all-time stock market highs, stretched valuations, record low bond yields, anemic economic growth, polarized political environment, and weak earnings growth, the probability of entering a bear market is material.

However, just because there is a heightened risk of a bear market does not mean that investors should reflexively “bail out.” Biblical wisdom certainly supports keeping one’s cool in the midst of adversity: “Do not fear, for I have redeemed you; I have summoned you by name; you are mine” (Isaiah 43:1). Further, while not directly addressing investment timing decisions, the Bible has many admonitions about making predictions and attempting to know the time and place of events.

Additionally, the evidence of financial history demonstrates that a strategy of “timing” the market by getting out when the market appears to be trending down and then attempting to adroitly get back in when the markets appear to have bottomed is fraught with risk, not the least of which is the necessity of being “right” twice. Additionally, research studies from Dalbar indicate that while the historical annualized return of the stock market (S&P 500) over the past 30 years (ending 12/31/18) is 10.0%, the average mutual fund stock investor return during the same time period has been just 4.1%. The biggest contributor to that underperformance differential was investors’ failed efforts to “time” the market, oftentimes being sucked into the market’s euphoria near market tops and “buying high,” while subsequently succumbing to despondency near market bottoms and “selling low.”

So, what is a biblically responsible investor to do in these circumstances? If an investor has a longer term (> 5 years) financial goal(s), then continuing to have a meaningful level of one’s asset allocation in the stock market is a prudent strategy despite the current market turmoil. In fact, further stock market weakness would likely be an opportunity to deploy more money into equities, i.e., buying low when stocks are on “sale.” Further, investors should consider the current market dislocations as an opportunity to “rebalance” their portfolios by trimming down slightly those assets which have performed better (e.g., bonds), and redeploying those proceeds into the recently beaten down asset sectors (e.g., domestic and international stocks, as well as commodities). Lastly, and most importantly, biblically minded investors should strive to keep these heartfelt concerns of life in their eternal perspective, including John 16:33: “I have told you these things, so that in me you may have peace. In this world you will have trouble. But take heart! I have overcome the world.”

Sources: Standard & Poor’s, Inspire Investing, and 2019 Dalbar Quantitative Analysis of Investor Behavior (2019)​


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

LinkedIn

*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Matters of the Heart

“For where your treasure is, there your heart will be also.”

Luke 12:34

The keynote address of every graduation ceremony that I have ever attended can be generally summarized as “Follow your heart!”. This message is certainly wise and insightful council for the young graduates as well as for their family and friends in attendance. For example, when considering a vocational path, “follow your heart” makes good sense as you don’t want to be stuck in an unfulfilling career path. Likewise, when making decisions about educational, geographical, avocational, relational, and many other questions, it seems reasonable to follow one’s heart. However, when it comes to financial matters, “follow your heart” may not be the most prudent course. In fact, when it comes to things financial, a good rule might be to “listen to your heart” and then do the opposite!

The Bible contains hundreds of references to the heart. Interestingly, however, rather than being a source of direction, the Bible often times speaks of the heart itself needing to be directed and turned. Matthew 6:21 and Luke 12:34 both describe how the heart goes to where one’s treasure is kept. 2 Thessalonians 3:5 asks that the Lord may “direct your hearts to the love of God and to the steadfastness of Christ.” Further, Luke 1:17 describes “the spirit and power of Elijah to turn the hearts of the fathers to the children, and the disobedient to the wisdom of the just”. While there is no question of the importance the Bible places on matters of the heart, the heart itself might not be the best source of direction as it is in need of its own guidance. In fact, Jeremiah 17:9 cautions that “The heart is deceitful above all things, and desperately sick; who can understand it?”. Therefore, simply choosing to “follow your heart” might not be the wisest path.

Investors often rely on their heart as a source of direction for their decisions. They have a good “feeling” about the market or a specific stock. Or their “gut” may make them wary about the investment environment. Investors often panic when the stock market falls and become euphoric when stocks soar. However, historical evidence shows that investors’ sentiment is a very poor indicator of future market performance. In fact, many have come to view investor sentiment as a contrarian indicator for the market. The longest running (since 1987), most frequent (weekly) measure of investor sentiment comes from the American Association of Individual Investors (AAII). A 2013 report by AAII about its own sentiment survey concluded that “extraordinarily low levels of optimism have consistently preceded larger-than-average six- and 12-month gains in the S&P 500”. In the study of Behavioral Finance, this is a classic investor decision-making error as following one’s heart is a recipe for disaster when it comes to investing.

So, in summary, purposely direct your heart to the love of God and to the steadfastness of Christ. Follow it in those areas of life where it makes sense to do so. However, when it comes to investing . . . don’t listen to your heart!


 


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

LinkedIn

*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

What’s the Purpose?

“You, Lord, give perfect peace to those who keep their purpose firm and put their trust in you.”

Isaiah 26:3-4

“What’s the purpose?” is one of the most important questions we can ask in life. To this central subject, the Bible provides the answers for us . . . in Matthew 22:37, Jesus says that “the great and first commandment” is “You shall love the Lord your God with all your heart and with all your soul and with all your mind.” In Ephesians 2:10, we see that “For we are his workmanship, created in Christ Jesus for good works”. While as to what is required of us, Micah 6:8 instructs “but to do justice, and to love kindness, and to walk humbly with your God?”.

On this question of purpose, Pastor Rick Warren has taught and written extensively on the importance of living a “purpose-driven life”. His best-selling book, The Purpose Driven Life, has sold 32 million copies and been translated into 85 different languages. Millions of lives have been impacted as they have come to more fully understand their life’s purpose in relationship with God. Knowing our purpose is everything.

Just as the question of “What’s the purpose?” is imperative for our life’s journey, it is also critical to our investment journey as well. When investing, there are many important, sensible questions for investors to consider, incl. “What’s the state of the economy?”, “What are the prospects for growth?”, “Is inflation a significant risk?”, “How do valuation levels look?”, “What about global trade?”, “Will the Central Bank be adjusting monetary conditions?”, etc. However, the first and most important question investors need to ask themselves is “What’s the purpose of the investment?”.

Over the course of my career, the biggest mistake I have seen investors make is by not first asking themselves “What’s the purpose of the investment?”. By not asking that question first, oftentimes investors will miscalibrate their investment strategy with their financial objective(s). If the purpose of the investment is for a short term (less than five years) goal such as a planned major purchase or expenditure, then a lower risk strategy, maybe even a “savings” strategy rather than an “investment” strategy is likely the best course of action. However, for those financial goals that are long-term (more than five years) such as young children’s college funds, retirement, a vacation home, estate plans, charitable bequests, etc. a longer term investment strategy is prudent. The other questions about the economic, market, and political environment while important, are all secondary to primary question of the purpose of the investment. Too often, investors make the mistake of focusing their attention on the prospects for the coming days, weeks, and months while their financial goals are oftentimes measured in years, decades, and even generations. This disconnect can lead to dire outcomes.

Knowing our purpose is very important as we go through life. Regularly recalling that purpose can help to guard us against the idols, distractions, and temptations of this world that call out to us every day. Likewise, knowing the purpose of our investments can help to keep us from the behavioral traps and temptations that afflict all investors to one degree or another. Knowing purpose is foundational to faith as well as to investing.


 

 


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

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*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Go Ye Into All The World

“And he said unto them, Go ye into all the world, and preach the gospel to every creature.”

Mark 16:15

I once heard an interesting observation that many people who live in rural areas can be very afraid of the perceived dangers of a big city…crime, traffic, strangers, etc. And as a corollary to that, many city dwellers can be exceedingly fearful of the risks to be found out in the country…wild animals, getting stranded, isolation, etc. This idiosyncrasy of human behavior is known as “familiarity bias” in that the risks with which we are most familiar appear less threatening to us while those risks with which we are less accustomed can be quite terrifying.

In investments, one of the most well-researched examples of this familiarity heuristic is what is referred to as “home country bias”. Home country bias is the condition by which investors show an excessive preference for investments emanating from their home market over those opportunities found in other parts of the world. With this behavioral predisposition, domestic risks generally seem relatively tame because they are more familiar when compared to those perils coming from overseas which are less well understood. While instinctual, home country bias could cause suboptimal decision-making by investors with possibly detrimental effects on their long-term investment results.

These days in particular, the flames of investors’ home country bias are reasonably being fanned by a litany of worries that are coming from outside our borders…China trade disputes, Brexit, Hong Kong protests, slowing Chinese economy, stagnating European economy, declining Japanese population, Middle East tensions, terrorist threats, etc. Add to that the recent outperformance of the US stock market versus the rest of the world and it is quite understandable that US investors are currently beset by home country bias. However, because of this familiarity bias, investors may be making the behavioral mistake of focusing on the risks of investing internationally while overlooking the opportunities that can be found abroad. Consider the following:

  • 96% of the world’s population is outside the United States.
  • Amidst concerns for the greying US population with a median age of 38.2, the median age for the other 7.2 billion people on our planet is much younger at 29.8.
  • While the US population growth is only 0.8% per year, the population outside the US is growing at 1.1%.
  • 85% of the world’s economic production (Gross Domestic Product) comes from outside the United States.
  • The US may have the world’s largest capital markets, but nevertheless 70% of the world’s securities (stocks and bonds) market value is found outside the United States.
  • The US economy (real GDP) is likely to growing around 2.3% this year, but the overall global economy outside the US will grow about 3.5%
  • The US stock market is near its all-time highs, however International Developed as well as Emerging Market stock market indices are both still 20% below their 2007 all-time highs.
  • While there is growing concern that US stock market valuations (Price/Earnings, Price/Book, etc.) may be getting a little lofty, valuations of International Developed and Emerging Market stock market indices trade at least a 25% discount to their US peers. Relative interest rate differentials make these even more attractive.

Sources: CIA World Factbook, Standard & Poor’s, MSCI, and Factset

While we do not know for sure, it is possible that the Disciples were also wrestling with their own home country bias as they pondered what to do next with their lives as their physical time with Jesus came to an end. Could that be why Jesus had to remind them several times about the importance of venturing into foreign lands? Once, with the Great Commission (Matthew 28, Mark 16, and Luke 24) and again just prior to ascension (Acts 1), we see Jesus’ instruction to go outside of their homeland. Even more so in today’s global society, the Bible’s instruction to go out into the world still applies. And as scary as it can be at times, the admonition probably applies even to investing!

Therefore, getting practical, as a general rule, it makes prudent investment sense to allocate between 25% – 50% of one’s equity exposure to International Developed and Emerging Market stocks. For example, if an investor’s overall portfolio allocation to equities is 60%, then 25% – 50% of that 60% should be allocated to international and emerging market stocks, i.e. 15% – 30% of the entire portfolio.

Go ye therefore into all the world!


 
 
 

 


Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA

Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

LinkedIn

*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Blessed are the Risk Takers

“He who watches the wind will fail to sow, and he who observes the clouds will fail to reap.”

Ecclesiastes 11:4

As human beings, our capacity to worry is quite exceptional. In a worldly sense, this predilection towards fear is very understandable as bad things do happen in our lives and in the world around us. In fact, at times our worry has likely kept us from danger or harm. Personally, I know that even as the years have gone by, I have found it very difficult to break the grip of fear in my own life. If anything, I can take some small comfort in the fact that the nature of my worries has changed as time has gone by. These days, I find myself still worrying, but about different things than I did in my earlier years. That probably does not count as progress though!

Given our very human predisposition to worry, it should be no surprise that fears are especially heightened when it comes to investing. In fact, the foundational theory in the area of behavioral economics, Prospect Theory, by Noble laureate Daniel Kahneman (author of Thinking Fast and Slow) and Amos Tversky showed that humans are so overcome by fear that we instinctively weigh loss and gain prospects unevenly thereby causing suboptimal decision-making. Especially in the wake of the trauma of the Financial Crisis of 2007 – 2009, investors are predisposed to see danger lurking around every corner. These days, the list of fears that investors face is quite long: trade disputes with China, Brexit, domestic political divisiveness, Hong Kong protests, inverted yield curves, recessionary concerns, etc.

Nevertheless, despite the enticing self-preservation benefits of fear, the Bible is filled with admonitions against it (Isaiah 41:10, Luke 12:22, etc.) because of the obstructive effect it can have on our God-given destinies. Many times in the Bible, the challenge is put forward to “fear not”. Both the Old and the New Testaments have numerous stories of ordinary people overcoming their fears and taking significant risks with extraordinary, even miraculous results (think Moses, Esther, the Disciples, et al.).

In the Parable of the Talents (Matthew 25), it is illuminating to read of the master’s praise, “well done, good and faithful servant”, for the two employees who took risks with the funds that had been entrusted to them. Yet, maybe even more instructive is the scorn directed at the servant who was afraid and went and hid the entrusted funds in the ground . . . “You wicked and slothful servant.” and “cast the worthless servant into the outer darkness”. If this isn’t a call to guard our hearts against acting out of fear, I don’t know what is!

Carrying over this Biblical call of risk-taking to investing, it is important for investors to be on guard against getting wrapped around the wheel of whatever the “worry of the day” may be. Rather, investors should undertake prudent risks aligned with the timeframe of their financial objective. Certainly, for short-term (less than five years) financial objectives such as planned major purchases or expenditures, risk-taking should be minimized. Actually, these sort of short-term financial goals are better viewed as “savings” rather than “investment” strategies. However, for those financial goals that are long-term (more than five years) such as young children’s college funds, retirement, a vacation home, estate plans, charitable bequests, etc. a spirit of prudent risk-taking is necessary in order to grow the funds while outpacing inflation and taxes.

The history of the stock market shows the wisdom of the Bible’s guidance on fear and risk-taking. Going back to its inception in 1927, the S&P 500, the benchmark U.S. stock market index, despite dramatic corrections and crashes, has had a total return of approximately 10% annualized. During this very long time period, despite prior generations’ “worry list” including wars, rise/fall of Communism, recessions, famines, assassinations, political discord, etc. there has never been a 14-year holding period in which the total return of the S&P 500 has been negative. Prudent risk-taking pays off over the long-term. Source: Standard & Poor’s

Obviously, “blessed are the risk-takers” is not actually one of the Beatitudes (Matthew 5). Nevertheless, investors who believe that the Bible has wisdom applicable to contemporary life are well advised to consider its guidance as it relates to fear and risk-taking as they make investment decisions.