People Have Memories. Markets Don't

By David Booth - Chairman & Founder, Dimensional Fund Advisors (DFA)

One of the best things about markets is that they don’t have memories. They don’t remember what happened last week or last year. They don’t even remember what happened a minute ago. Prices change based on what’s happening right now and what people think will happen in the future. People have memories. Markets don’t. And that’s a good thing.

Every day in publicly traded financial markets, buyers and sellers negotiate prices for every stock and bond. To agree, they have to find a price that they both think is a good deal. This happens over and over, millions of times a day. Then it starts all over again the next day. Unlike people, markets don’t think about the past. It’s about today and expectations for the future.

Markets must be forward-looking to set prices that entice buyers to buy. But prices can't be too low or sellers won’t sell. Every piece of available information feeds into the decision-making process so everyone involved can agree on the price for a particular security at a particular moment.

Markets are smarter and faster than you and me. While you’ve been reading this, markets have factored in thousands of pieces of new information and adjusted the prices of thousands of different company securities. That’s good news.

Some people might think I’m giving the market too much credit. But over more than 50 years in finance I’ve come to realize that I’m just being realistic. Someone described it to me as “science-based hope.” You don’t need to believe in magic or be able to predict the future to have a good investment experience.

Academic research gives us insights into investing. Over the past century, markets have returned on average about 10% a year, although almost never that amount in any given year. And the annualized inflation-adjusted return on US stocks is 7.3% going back to 1926.

Because of big swings year to year, trying to time markets is a losing game. So don’t try to outguess markets—stay with them. Come up with a plan, take no more risk than you can tolerate, and go spend some time with your loved ones.

Start the year off with a clean slate—just like markets do every day.