Most of our commentaries deal with (relatively) hard data. This one will not.

This morning I found myself having this discussion for the 3rd time in three days. With such growing popularity, I’ll guess that there may be a few of our faithful readers that have the same issue on their minds. Perhaps you are one of them.

Here’s the conclusion first, and then a bit of background. YOU are most likely a person! Not a robot or a spreadsheet, but an actual human being: with all the accompanying weaknesses and shortcomings all of us share. However strongly we try to avoid it our emotional — and non-rational self — steps forward straight onto center-stage. That’s OK. In fact, it may be better than OK.

Yes, the point here is simply that it often doesn’t work to attempt to be totally rational when making life decisions about things that have emotional components. For instance, financial decisions. On the other hand, being reasonable instead of totally rational seems to work pretty well. It also has the added benefit that you may find it easier to stick with your decisions about managing your money and financial affairs. It took me rather a long time to figure this out, but it has been one of the most important parts of finance and I seem to find myself repeating it over and over.

The study of finance is devoted to finding mathematically ideal investment strategies. My theory is that in the real world (where we really live) people do NOT want an optimal or ideal investment conclusion. Instead, they gravitate toward a strategy that optimizes the quality of their nightly sleep.

You may have heard of Harry Markowitz who won a Nobel prize for work done exploring the tradeoff between risk and return. His publications basically said: “Own stocks”. However, when asked how he invested his OWN money he said he was unhappy when stocks went down so invested in a balanced mix of stocks and bonds, despite his awards for publishing info that said stocks are a better investment. (He did eventually change to a mix of primarily stocks for himself!) The takeaway here is that it’s hard to rationalize on paper the benefit of NOT having regrets in the future when markets go down- but that’s the tradeoff he paid for giving up more potential returns in exchange for sleeping better.

You (or I) might make a rational decision when crunching the numbers in your office (based on the FACTS- just the facts!) and quite another perhaps more REASONABLE decision when you believe that your spouse will sleep better with a different decision that you make regarding your family’s finances.

And this is a GOOD thing. We (people) are not rational and generally not irrational. We are ‘just’ human. We don’t think harder than we need to, and have tons of items pulling for our attention at all times (or so it seems). With that in mind, it’s perhaps not a surprise that the pioneer in modern investment theory built his investments (initially) without regard to his own Nobel Prize-winning research. And I guess it’s not a surprise either that he changed his mind later.

As a human, he was just being ‘reasonable’. So sometimes a system might be rationally correct but totally unreasonable. I’ve read that one theory of investing is to leverage all of your savings (borrow more) and keep it all in high-growth stocks. The math works on my computer. It’s rational. The thing that gives the computer such confidence is that it doesn’t care if it’s right or wrong! On the other hand, I don’t believe most people could watch their entire retirement savings disappear in a big market crash, and just continue on. It really might work on paper, but I believe they would quit and try something else. Researchers have shown that a rational person would eventually most likely achieve excellent results with this (high risk) strategy. But is it reasonable?

And so, if you’re contemplating a strategy or financial decision, keep one more example in mind (clients have heard this a few times). A smaller shoe size (ladies) might look a tad better on your feet than your correct shoe size. It may also be a bit to a lot uncomfortable and keep you up at night with sore feet. It may be rational to wear the smaller shoe because it works, but perhaps it would be unreasonable.

And to summarize, if your investments work but keep you up at night, they might not be reasonable FOR YOU. In my case, having too much cash earning nothing (zero, zip, zilch, nada, bupkis!) might keep me up at night. Someone else might lose sleep over having too little cash available. There is no one answer that works for all of us, but I believe it’s important to find the answer that works for YOU. Reasonable, don’t you think?

Ron’s Market Minute — More Volatility on the Way?

The past few weeks have been quite volatile for markets, giving us sharp drawdowns and nearly equally sharp rebounds. This seems to be the result of interest rates rising, and this has led to a hammering of growth stocks. 

With this day-to-day volatility, many investors are confused and are thus unable to draw a conclusion regarding their expectations of what happens next. Is it time to bet on near-term drawdowns, or on longer term rising markets? The uncertainty appears to have pushed a number of investors — who are unable to discern the trends — to instead bet on volatility as the answer for their investing dollars. And many have invested in this ‘bet’ by buying call options on the VIX- the volatility measurement. 

The view from my chair looks like this: the more-than-huge-a-mungous ‘stimulus’ bill (which was just passed) appears (since I have only read summaries of the bill, not the actual bill) to contain a large amount of pork — or dollars for causes other than rectifying problems caused by the Covid virus. Along with these huge numbers of new debt and new dollars flowing into the economy, we expect that inflation will be increasing — and pulling interest rates upward along with it — for a while at least. With the increasing interest rates, we expect more pushing and pulling of growth stocks, and even if stocks basically go nowhere, the volatility will likely increase. This gives the buyers of call options on the volatility index profits — so they may get to be winners. 

I expect the huge dollars flowing into markets to result in the S&P Index* to rise to over 4000 for the first time ever, so investors may all benefit from this, but it’s likely to be a very bumpy ride!  Hang on!

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk
www.denkinvest.com

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Ron Denk is a Registered Representative, offering investments through Lincoln Financial Securities Corporation, Member FINRA/SIPC.

Mr. Denk is also an Advisory Representative offering services through Denk Strategic Wealth Partners, a Registered Investment Advisor. Denk Strategic Wealth Partners is not affiliated with Lincoln Financial Securities Corporation.

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Past performance is not a guarantee of future returns.