The Making of Dreams

Are market changes real?

There’s a common understanding that market gains or losses aren’t real gains or losses—they’re only “on paper” until the investor sells the stock, 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 goes from $100 to $200 per share, that gain is real. And when it drops to $170, that loss is real. The portfolio’s total value has changed. When we calculate total return we incorporate these temporary changes.

But there’s a sense in which the common sentiment is accurate. Our gains and losses are realized when we sell, and we have to report them on our taxes. Those 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.

But there’s another sense in which the common sentiment is true: when we alter our asset allocation in response to the market’s gyrations, we take temporary changes in valuation 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—say, trimming a position to stay inside of policy 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 The Tempest the main character Prospero tells his daughter and her fiancé that “We are such stuff as dreams are made on, and our little life is rounded with a sleep,” (Act IV, Scene 1). Life is fragile, and what’s here today may be gone tomorrow. It’s true with our money, and it’s true in other things: much of what we experience is “but a dream.”

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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By |2014-09-18T09:54:18+00:00July 31st, 2014|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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