It has been said that although history does not repeat, it surely rhymes.  According to the Stock Trader’s Almanac, the direction of January’s trading predicts the course for the year 75% of the time.  If this is the case, the infamous January effect for 2016 would seem to be ominous for investors, right?  I hope to make the case that with the right approach, investors can likely ignore the performance of their portfolios in January as it only represents yet another cog in the machine.  Long term results in a goal-based investment plan is what investors should covet.

What the January effect is and what its results have been

This article describes the January effect pretty well so I won’t use this blog post to do us.  Suffice to say, the formula is pretty accurate in most years.  However, I believe the power of the effect often gets lost.  I will explain.  The power of the January effect happens to be the depressed pricing of stocks relative to normal levels.  And how do they get to these depressed prices?  Well, typically investors (both retail and institutional) will sell stocks to trigger a taxable event. (You can read more of why this happens in an earlier post.) This tremendous selling pressure results in prices for stocks being lower relative to where they have traded the whole year.  Subsequently, investors realize that prices are lower and do a lot of purchasing in the month of January.  But perhaps the only reason this even happens during this time of year is because the IRS imposes a deadline to claim investment losses as a deduction by December 31st.  My point being that bargain prices can be sought for assets at any time and the power of the effect comes when selling pressure is exerted on the market.

How a goal-specific investment plan will help calm investor anxiety regardless of market performance

So now you may be saying that is great, but how does that help my investment portfolio.  I would argue that it will if you are not trying to trade the market via timing or any other method.  However, if you are investing with a specific long-term goal of gains exceeding inflation along with current income, you can benefit nicely.  I think that most investors fail to realize the merit in this approach because they “chase returns”.  Further, they fall prey to anchoring bias, by focusing on one piece of largely irrelevant information to formulate their investment strategy.  The benefits of using a broader perspective is rarely sought and they subsequently underperform the market.  Whereas, if they approached investment with a goal to earn x% over a set period of time, adjusting for live events and other important considerations they would find much more success.  I have conversations all the time with clients that agree that this approach makes sense, but several obstacles stand in the way of their “follow-through”.  More than likely, their fear of repeating a disastrous loss in the past outweighs the logic of a sound plan for the future.

What you can do to formulate a goal-based plan

Some of the best work I have read on goal-based investing is by Ashvin Chhabra.  His approach is an expansion of modern portfolio theory with the incredible insight to consider what I would call “life checkpoints”.  Each investor has in their mind what would send them into poverty, keep them at their current lifestyle or catapult them into another tax bracket. These three checkpoints provide all the context needed to form a goals-based plan. Incorporating these into an investment plan allows both the investor and adviser to have a language to communicate what defines success.  Rather than it being a number that is basis points above or below a market index, it becomes a way to articulate “how we are doing”.  Regarding Chhabra’s approach, a recent blog sponsored by the CFA Institute read how it “goes beyond modern portfolio theory by shifting investment strategy from a focus on the securities held in your portfolio to a consideration of your personal objectives” — for example, saving for college, retirement, or to start a business.”  These tangible objectives should help to ease anxiety during market turmoil.  Why?  Because if you have set aside enough capital to live on for the next 2-3 years regardless of what the market does, you will rest easier if you see your portfolio going down.  This does not mean you may not need to make an investment plan adjustment, but it should keep you from calling your adviser requesting him or her to sell everything.  Just some food for thought.

Invest wisely.