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Don’t bail over 'Breakevenitis'

14 May 2019

Damian Ornani, chief executive at Fisher Investments, considers 'breakevenitis' and the temptation to dump stocks after they have recouped previous declines.

By Damian Ornani,

Fisher Investments

After steep declines late last year, stocks have emerged to a sunnier 2019. So much so, actually, that the S&P 500 retraced its entire decline and hit new all-time highs on April 12 – about three-and-a-half months from its low.

Anytime stocks return toward highs after a volatile stretch, I hear some clients talk of getting out. Scarred by the volatility, they feel like they just “dodged a bullet.” Now they want “off the rollercoaster ride”. While this sentiment is understandable, it can be a function of a common investor malady I like to call “breakevenitis”.

Breakevenitis is the temptation to ditch stocks after markets recoup a prior decline. Usually, I find folks talk this up when markets near prior highs, but that isn’t always the case – it could be some arbitrary number, a portfolio value or something else. But breakeven is what I hear most. It is an easy way for folks to rationalise exiting markets – after all, breaking even means they didn’t lock in losses.

Now, rationally, few investors buy stocks planning to hold through a dip and exit after flattish returns. They do it, in my view, because humans aren’t always rational. Behavioural theory and mountains of evidence show humans feel the pain of loss more than twice as much as the pleasure from an equivalent gain.

Nobel laureate Daniel Kahneman and Amos Tversky proved this very point in their study of prospect theory. Breakevenitis likely stems from losses’ fear and sting lingering. So when stocks recover to prior highs, those suffering from breakevenitis want to avoid going through the gut-wrenching experience again. To them, breaking even feels like a win.

But this is just a rationalisation for what amounts to a backward-looking decision that may harm your ability to reach future investment goals. Selling because stocks broke even is akin to driving by looking exclusively in the rearview mirror. Markets don’t look back, though, and you shouldn’t either. They are forward-looking, moving on expectations of economic growth, political developments and profits. These should factor heavily in your analysis of the future—much more heavily than arbitrary past numbers.

Asset allocation – the mix of stocks, bonds, cash and other securities you invest in – is a major determinant of your longer-term return. Getting your asset allocation right is key. To me, this requires weighing your goals, retirement cash flow needs (if any), time horizon, inflation and more. Your asset allocation should target these, mixing assets likely to generate sufficient return to finance them. Hence, changing this is a risky endeavour – especially when it is motivated by past market movement.

To the degree meeting these aims requires stocks in your portfolio, expect near-term volatility. This is natural and the price-tag for reaping stocks’ higher longer-term returns. There isn’t any way around that.

If you absolutely cannot stomach volatility, you may need to revisit your goals. That is the trade-off between volatility and return. A “volatility-free” portfolio allocation may not swing, but it carries its own risk!

Having all or most of your money in cash would be stable. But quite possibly too stable—the low returns cash or cash-like securities sport over the long run could hamper you from reaching your goals or cover cash flow needs, particularly when inflation is concerned. Hence, if you seek no volatility (or even very low), you may have to reassess goals, cash flow needs, retirement targets and more. It could be a totally different retirement than you initially pictured. There just isn’t a magic bullet that provides both capital preservation and equity-like growth. If you hear otherwise, tread carefully—they are selling snake oil.

In the end, there are no shortcuts. Withstanding short-term negativity – and then persevering – is critical to enjoy long-term gains and reach your financial goals. Don’t let pain from past volatility spook you into a backward-looking decision that can put all you have saved and invested for at risk.


Damian Ornani is chief executive officer of Fisher Investments. The views expressed above are his own and should not be taken as investment advice.

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