Using Deep Analytics to Align Risk Perception
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The extreme volatility from November 26 to December 3 caused many clients to panic. By using deep analytics, advisors can illustrate that this episode – and others like it – were not that unusual.
Our perception of the market is influenced by recent events, a behavioral trait known as the “recency bias.” Risk perception is an integral part of a risk-measurement framework, and irrational responses are often triggered by the wrong perception of market risk.
How do we get a more reliable sense of market risk? Daily prices are readily available, but they have too much noise. We need an average to see how it changes over time. One way of doing it is to use the one-month rolling return.
Figure 1 shows the one-month rolling return for a 60/40 balanced portfolio – 60% SPY and 40% BND – for the past three years (from December 3, 2018 to December 3, 2021). By calculating the one-month rolling return using daily prices, you can see the huge dip in early 2020, the subsequent strong recovery, and the recent market decline towards the end of the chart.
Figure 1. One-month rolling return for a 60/40 balanced portfolio from 12/3/2018 to 12/3/2021
Source: Andes Wealth Technologies.