Market Dreams

Are market changes real, or are they more like dreams?

Dreams of World War 1 soldiers, by Jan Styka. Source: Lublin Museum

There’s a common thought that market gains or losses aren’t real gains or losses – they’re only “on paper” until investors sell their holdings, making them “real.” But that’s a cognitive error – a kind of egocentric bias that says that something is only real if it affects me. In fact, price changes are real changes. When IBM went from $100 to $200 per share, that gain was real. And when it dropped back to $140, that loss is real. The company’s value is different than it was a year ago. When we calculate total return we incorporate these price changes.

But there’s a sense in which the common sentiment is accurate. Our gains and losses are realized when we sell, and we’re required to report these on our taxes. The tax consequences are quite real: money paid to the IRS isn’t coming back. That’s why tax-losses become an “asset” in the topsy-turvy world of tax accounting.

Photo: Steve Buissinne. Source: Pixabay

But there’s another sense in which the common sentiment is true: when we change our asset allocation in response to the market’s gyrations, we take fluctuations in value and make them more-or-less permanent. That doesn’t happen when we sell one stock and buy another. We’re not taking money off the table, we’re just changing where we place our bets. But when we shift from stocks to cash (or short-term bonds), we go from a higher-risk asset to a lower-risk asset. That can be for good reasons, like trimming a position to stay inside of our limits – or bad ones, like selling out when the market’s volatility scares us. But our behavior can turn temporary gains and losses into permanent changes in a portfolio’s value, depending where we put the proceeds.

In Shakespeare’s Tempest, the main character Prospero tells his daughter that “We are such stuff as dreams are made on, and our little life is rounded with a sleep.” Life is fragile, and what’s here today is gone tomorrow. It’s true with our money, and it’s true in other things, too: much of what we experience is “but a dream.”

Douglas R. Tengdin, CFA

Charter Trust Company

“The Best Trust Company in New England”

By |2018-07-02T07:50:24+00:00July 2nd, 2018|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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