Another Historic Rate Hike… Plus: Want To Unlock Market Riches? Here’s What You Need To Understand…
As anticipated, the U.S. Federal Reserve raised interest rates by 75 basis points today.
It was the fourth straight hike as the central bank continues to try to rein in stubbornly high inflation.
None of this was a surprise. As mentioned previously, the market wanted to know today whether there would be any hints of a slower pace of hikes after this month.
In its official policy statement, the Fed weighed in on that prospect:
“In determining the pace of future increases in the target range the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation and economic and financial developments.”
If that sounds like the Fed is hedging itself, that’s because it is. While acknowledging that the impact of its decisions will take some time to filter through the economy, the central bank is leaving ample room for continued rate hikes.
This latest hike will bring the federal funds rate up to a new range of 3.75% to 4%, up from a current range of 3% to 3.25%. That will put rates at their highest level since 2008.
Stocks turned green after the statement was released. It seemed the market was interpreting the statement as a sign that future rate hikes may moderate (a 0.5% or 0.25% hike, for example, instead of 0.75%). In other words, the end of rate hikes may be in sight.
But then Fed Chair Jerome Powell threw cold water on that notion. Here’s what he said in his press conference following the decision, courtesy of Yahoo Finance:
“It is very premature, in my view, to think about or be talking about pausing our rate hikes,” Powell stressed. “We have a ways to go. Our policy, we need ongoing rate hikes to get to that level of sufficiently restrictive [territory] — and of course, we don’t know exactly where that is. … I would expect to us to continue to update it based on what we’re seeing with incoming data.”
Powell admitted that the path is “narrow” to a so-called “soft landing.” In other words, the Fed will have to continue its restrictive policy of raising rates to ensure inflation is sufficiently tamed.
We’ll have more to say about the impact of this decision in the days and weeks ahead. In the meantime, below, you’ll find an updated essay I’d like to share with you. It’s about how emotions and psychology impact our choices regarding money and investing.
I hope you find it enlightening. As always, you can email me if you have any questions or would like us to address a certain topic.
Want To Unlock Market Riches? You Need To Understand This First…
In the past, we’ve talked about how many studies show that individual investors underperform the broader stock market.
Of course, we each have our own unique needs and goals, and sometimes they don’t require major gains. Things like capital preservation or income are important in some situations, too.
But what really tends to ruffle some feathers is when I say that most individual investors are bad at investing. I don’t say this to be deliberately controversial. I say it because it’s what people need to hear.
In a raging bull market, it’s easy to feel like a genius. Don’t get me wrong… big wins are great. But part of our job is to not only provide ideas in the form of stock picks — but to help you actually be better than the average investor.
To do that, one of the things we have to do is go back to try and understand why most individuals are bad at investing. If we can wrap our heads around that, we can begin to remedy the situation.
And that’s why it’s essential to understand some basic human psychology. So let’s have a little fun today with a thought experiment…
Heads Or Tails…
First, I’ll present two scenarios. Then I’d like you to think about what you would do in each one.
Scenario 1: Imagine that you have just been given $1,000. You have to choose between two options. With option A, you are guaranteed to win an additional $500. With option B, you are given the chance to flip a coin. If it’s heads, you receive another $1,000; tails, you get nothing more.
Which option would you chose?
Got that? Good, now stay with me here…
Scenario 2: Now imagine that you have just been given $2,000. You must choose between two options. With option A, you are guaranteed to lose $500. With option B, you are given the chance to flip a coin. If it’s heads, you lose $1,000; tails, you lose nothing.
Now which option would you choose?
I picked this up from Gary Belsky and Thomas Gilovich’s book “Why Smart People Make Big Money Mistakes.” I’ve mentioned this book off and on over the years — it really is one of the best books out there if you want to understand behavioral economics. (I highly suggest you pick up a cheap used copy on Amazon or at your nearest bookstore. It’s a quick read.)
Here’s what they have to say about the two scenarios…
Traditional economic theory used to tell us that the market is made up of rational actors. This means people make rational financial decisions based on the probability of future events. And by this logic, you would be consistent with your decisions in both cases.
After all, if you choose option A in scenario 1 and scenario 2 — the certain gain in the first version or the certain loss in the second — you end up with $1,500 either way. With option B, you have a fifty-fifty chance of ending up with $1,000 or $2,000 in each scenario.
See what I mean? (Go back and re-read this if you need to…) In other words, the only thing that should matter to you is whether you’re willing to take the certain but smaller gain or whether you’re willing to gamble to win more money.
Make sense? There’s just one problem, though…
As Belsky and Gilovich point out, that’s not how most people think. When they tested these scenarios on a group, nearly all chose option A in the first (guaranteed to win an additional $500) and option B (lose $1,000 with heads, lose nothing with tails) in the second.
Think about that for a second. Why on earth would they do that? It makes no sense!
The answer is easy. It’s because they’re human…
The field of behavioral economics teaches us that humans are not rational when it comes to finances. This is apparent in the two scenarios above. Humans tend to be more conservative when it comes to booking a sure gain, whereas we’ll take more risk if it means avoiding certain losses.
As Belsky and Gilovich note, this explains why gamblers tend to increase their bets when they start losing money. They’re willing to be more aggressive to avoid finishing in the red. It also helps explain why most investors sell their winners too early and hang on to their losers for far too long. The fear of losing money on a stock is far more potent than the joy of achieving additional gains.
Ask yourself how many times you’ve sold a winning stock just to see it surge in the days and weeks that followed. On the flip side, think about how many times you’ve held on to a loser just to see it keep falling. As you can imagine, this tendency can have a devastating effect on an investor’s portfolio.
Terrance Odean, another behavioral economist, found that the stocks investors sold outperformed those they continued to hold by roughly 3.4 percentage points in the 12 months following the sale. You don’t need a Ph.D. to understand that, over time, those 3.4 percentage points add up.
It’s important to understand our psychological makeup as humans. What’s more, understanding what makes us tick personally is even more crucial. We all have them. And if we work to overcome those tendencies, our portfolios will be on the path to bigger profits.
If you’re interested in learning more, here’s a short list of cognitive biases from Magellan. If you scan through them, you might be surprised to see which ones you have.
In the meantime, with just a handful of days left before the midterm elections, legal weed stands at the biggest tipping point in history…
That’s why our colleague John Persinos hosted a special online investor town hall, called the “Marijuana Millionaire Countdown.”
If you’ve been waiting for the right moment to profit from pot stocks, this is it… John has spent the last couple of years researching and chronicling this emerging sector in meticulous detail — and he’s got the inside scoop on how investors can profit.
The event is free to any investor who wants to check it out. Go here now for instant access…