2020 05 18 Feature article base rates Capture

Many investors, particularly retiree investors, want to preserve the lifestyle that they have.  They want to take back control and maintain their self reliance in the face of a highly uncertain world.

Nobel Laureate in Economics Daniel Kahneman draws together his lifetime of research in “Thinking, fast and slow”.  He challenges the rationale model of judgment and decision making and incorporates psychology to optimise structures to improve the outcomes for humans – to deliver what they really want.

Kahneman observed “When they made decisions, people did not seek to maximize utility.  They sought to minimize regret.”

Portfolio structure to help investors address uncertainty

An approach that has been well recognised to work for all market conditions is to construct a portfolio with diversified non-correlated assets. 

How to deal with uncertainty?  Base rate scenario planning asset allocation

In a world of such uncertainty, Kahneman and Tversky suggest that you start with a ‘base’ rate.  Ie:  What would you predict if you had no information at all.

The base rate is that stock markets will re-test previous falls.

“… in 19 of 19 post-war instances of a 15% uninterrupted decline (excluding the current one), the stock market ended up re-testing the waterfall low in some fashion. Basically, markets tend to rally after “waterfall” declines. Until recently, test case #20 (Q4 2018) was the outlier. That low has now been re-tested.”


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