Economic Laws Cannot Be Depended Upon if We Disregard Psychology

“Economic laws cannot be depended upon if we disregard psychology, etc.”
-Alma Volker

Alma Volker scribbled the note, quoted above, in the margin of a 1911 economics textbook, Outlines of Economics, written by Vassar College Professor Herbert Elmer Mills. Later her son, Paul Volker, who has served six presidents over his long career in public service, shared his regret of never discussing economics with his Mom in his recent book Keeping At It.

This book may be Mr. Volker’s memoir, but to me it is a stark memory of my own history in the world of investment management. When he recalls those first few years after he assumed the chairmanship of the Board of Governors of the Federal Reserve System, I am drawn back in time to my own first few years in the business.

It was during this time that I experienced first-hand the truth of Alma Volker’s note; psychology drives investor decisions far more than economics. When Mr. Volker raised interest rates to beat inflation out of our lives, it created one of the greatest opportunities for anyone with a few dollars to invest. You could easily buy a 10 year FDIC Insured CD paying over 15%. AAA Rated Municipal bonds paid over 14% for periods of 20 years or longer. Common stocks were priced at 7 times earnings (an earnings yield of 14%) while paying a 7% dividend yield. Yet few took advantage of this opportunity. After all, common stocks had done nothing but lose money for over a decade. The supposedly safe bonds paying 8% or more just a few years earlier were worth 35% less than when they were purchased. This proved to me that for us mere humans, any rational thought is bent by short term price movements.

Through September of this year most of us were comfortable, as our portfolios were producing a positive rate of return. How quickly that changed as those positive returns rapidly turned into losses. Declines impacted investors around the world. Let’s take a look at the annual returns for a few major world stock markets as provided by Jill Mislinski of Advisor Perspectives for 2018:


2018 Price Return



S&P 500 (United States)


CAC 40 (France)


Nikkei 225 (Japan)


FTSE 100 (United Kingdom)


Hang Seng (Hong Kong)


DAXK (Germany)


Shanghai (China)


Granted, most of us will never have a portfolio that is 100% invested in common stocks. Nor would we own multiple index funds from around the world. Even a conservative investor who limits the amount of funds invested in common stocks had a hard time making any money in the past twelve months. Let’s look at the average returns provided by mutual funds that allocate money across various types of asset classes, the most common of which are stocks, bonds, and cash and or cash equivalents. These results are the simple average of allocation mutual funds that report results to Morningstar as of December 31, 2018:

Allocation Fund Category

Last Three Months

2018 Total Return

Allocation 15% to 30% Equity



Allocation 30% to 50% Equity



Allocation 50% to 70% Equity



Allocation 70% to 85% Equity



World Allocation