Narrow framing is a term in behavioral economics that describes evaluating a risk in isolation rather than mixing it with other risks, causing one to make intuitive decisions rather than systematic reasonable decisions. When using narrow framing, two other powerful factors appear—loss aversion and regret.
For example, I offer to flip a coin and if it lands heads, you win $10,000, but if it lands tails, you lose $1,000. Countless studies such as this have been conducted and the overwhelming majority of participants decline the offer, proving the power of loss aversion and the fear of future regret if one were to instantly lose $1,000.
Now, if I were to offer the same experiment not with one coin flip, but rather repeated 100 times over, suddenly the offer becomes more appealing. The expected net return of 50 heads (win $500,000) and 50 tails (lose $50,000) is $450,000. The chances for any negative net return after 100 coin flips are extremely remote. This is an example of broad framing.
These biases or mindsets are important for investors to notice at all times, but especially when stock market returns deviate far from the norm, whether the very positive experiences of 2019 and 2021 or the negative of 2022.
Amid the flurry of 24/7 headlines (extreme narrow framing), it’s easy to lose track of where the U.S. economy and the markets are, and to think about where they are heading. Here is a summary of the markets’ performance in 2022, beside their respective historical annualized average returns for broad framing assistance:
- S&P500: -19.95% (average 7.97% since 2000)
- DJIA: -9.20% (average 9.23% since 2000)
- Nasdaq: -33.89% (average 7.53% since 2000)
- Crude Oil WTI: 6.71% (average 9.63% since 2000)
- Gold: -0.13% (average 24.95% since 2000)
- Bloomberg US Aggregate Bond: -13.01% (average 4.11% since 2000)
- Bitcoin: -64.15% (average 719.23% since 2009)
- Tesla: -65.03% (average 583.92% since 2010)
- Amazon: -49.62% (average 114.90% since 2000)
- Occidental Petroleum: 117% (average 25.53% since 2000)
From a framing standpoint, this data allows us to compare a narrow frame of the 12 months of 2022 compared to the broader frame of the first 22 years of this century. But how narrow is narrow and how broad is broad enough?
Based on the info above, gold might appear attractive, but the astute investor might recall that gold spent most of the 1980s and 1990s in a steady decline, and the majority of its 21st century gain occurred in the first decade. Occidental Petroleum’s returns look great this year and in the aggregate since 2000, however an investor who purchased the stock at its peak in April of 2011 is still down 37.08%! Timeframes that include any IPO (initial public offering), like Tesla or the origin of Bitcoin, naturally reflect extreme volatility in its early stages.
The moral of this 21st century example is that across a broad representation of indices, commodities, and stocks, over a relatively broad timeframe, all have positive total gains and average returns. Yet, depending on narrow time frames they each have played the hero and the villain to investors’ portfolios.
This reinforces the need for investors to commit to the financial plan that fits their risk tolerance and goals, or risk the harmful mistakes inherent to emotional decision-making within narrow frames.
This is the broad and unemotional approach to wealth management I deploy with my clients’ accounts and financial plans. With that said, we do seek to achieve relative gains within each client’s risk parameters through rebalancing and reallocation based on what we believe to be discounts within the markets. While nearly every major asset class, except for oil and cash, did finish 2022 in the red, value investors fared better than the overall market and clients who own fixed annuities, buffer annuities, and/or Whole Life cash values far outpaced the beating fixed income took this past year.
Looking forward, the proverbial elephant in the room for 2023 is the word “recession”. While economists can debate what qualifies as a recession (see articles and podcasts I produced recently on the technical term), and many posit that the Fed is trying to create a recession to end inflation, what matters most to investors is the markets’ expectations. Remember that, historically, the stock market has performed worst leading up to a recession and has benefited from a rebound while in the middle to end of a recession. Hence the stock market’s reputation as a leading economic indicator.
While there is never one perfect investment, and what appears perfect today certainly was not yesterday nor will be tomorrow, I am confident that the diversified plans and protection-first philosophy our firm utilizes will continue to yield beneficial results.
Bryan M. Kuderna is a Certified Financial Planner and the founder of Kuderna Financial Team, a New Jersey-based financial services firm. He is the host of The Kuderna Podcast. His new book,"WHAT SHOULD I DO WITH MY MONEY?: Economic Insights to Build Wealth Amid Chaos" is now available for preorder.
2022 returns from Yahoo Finance. Bloomberg US Agg Total Return from Bloomberg.
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