November 2016
Mitigating behavioral
finance influences
Fundamental Index® strategies may help investors mitigate behavioral finance influences, and when used alongside
cap-weighted index strategies, can enable more effective market-cycle participation.
Stocks tend to recapture their valuations over time.
In momentum-driven environments, stocks that consistently outperform can reach
overinflated valuations. Accurately predicting when sentiment will shift away from such
recent “winners” is statistically improbable, whether considering equities within U.S.
or international markets. The unexpected rebound in U.S. Energy and emerging market
Insights from
Omar Aguilar
CIO, Equities
and Multi-Asset
Strategies
stocks in 2016 helps to illustrate this point and is demonstrated in the chart below.
Key takeaways
In momentum-driven markets,
outperforming stocks can
reach overinflated valuations.
Accurately predicting when
sentiment will shift away
from such recent “winners”
is statistically improbable.
The Fundamental Index
methodology seeks to break
the link with price and
market-driven emotion.
Sources: Bloomberg; Charles Schwab Investment Management, Inc.
Behavioral finance factors can help to perpetuate momentum-driven markets.
When a stock is performing well, the importance of employing a disciplined approach
to rebalancing can be easy to forget. After all, why sell a stock that is outperforming?
This mindset reflects the behavioral finance effects of the “hot-hand fallacy,” or our
propensity to maintain a winning strategy. “Loss aversion”—another behavioral finance
concept—can manifest itself as a reluctance to buy recently underperforming stocks,
even when they seem attractively valued with greater upside potential than currently
Fundamental Index and
cap-weighted index strategies
are natural complements, and
better when used together.
Including both strategies in
a portfolio can potentially
mitigate behavioral finance
influences, enable greater
market-cycle participation,
and diversify return streams.
outperforming stocks.
Fundamental Index strategies may help mitigate behavioral finance influences.
The Fundamental Index methodology systematically identifies fundamental measures and value metrics, seeking to break the link
with price- and market-driven emotion. These indexes rebalance quarterly, giving them the potential to mitigate behavioral finance
influences like the hot-hand fallacy and loss aversion behavior. In addition, including both Fundamental Index and cap-weighted
index strategies in a portfolio can diversify return streams and help to enable participation in a greater variety of market cycles.
Charles Schwab Investment Management, Inc.
For more insights, visit us at csimfunds.com
Learn more
Watch a third-quarter Schwab Fundamental Index Funds/ETFs* performance review.
Contact one of our regional sales professionals at 877-824-5615.
Past performance does not guarantee future returns.
There can be no assurance that the Fundamental Index methodologies will achieve their desired outcomes. Each investing
strategy involves its own set of unique risks and benefits.
Investment value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost.
*Schwab is a registered trademark of Charles Schwab & Co., Inc. Fundamental Index is a registered trademark of Research Affiliates LLC.
1
The performance of U.S. energy stocks is represented by the S&P 500 ® Energy Index, while the performance of emerging market stocks is represented by the MSCI Emerging
Markets Index. Information cited for both indexes is based on rolling weekly figures.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and
regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Frank Russell Company (Russell) and Research Affiliates LLC (RA) have entered into a strategic alliance with respect to the Russell Fundamental Index Series. Subject to RA’s
intellectual property rights in certain content, Russell is the owner of all copyrights related to the Russell Fundamental Index Series. Russell and RA jointly own all trademark
and service mark rights in and to the Russell Fundamental Index Series. Schwab is not affiliated with Russell or RA. Schwab Fundamental Index Funds are not sponsored,
endorsed, sold or promoted by Russell or RA, and Russell and RA do not make any representation regarding the advisability of investing in shares of the Funds. Russell and RA,
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The opinions expressed are not intended to serve as investment advice, a recommendation, offer, or solicitation to buy or sell any securities, or recommendation regarding
specific investment strategies. Information and data provided have been obtained from sources deemed reliable, but are not guaranteed. Charles Schwab Investment
Management makes no representation about the accuracy of the information contained herein, or its appropriateness for any given situation.
The views expressed are those of Omar Aguilar and are subject to change without notice based on economic, market, and other conditions. Some of the statements in this
document may be forward looking and contain certain risks and uncertainties.
Charles Schwab Investment Management, Inc. (“CSIM”), the investment advisor for Schwab’s proprietary funds, and Charles Schwab & Co., Inc. (“Schwab”), the distributor for
Schwab Funds, are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation.
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Charles Schwab Investment Management, Inc.
For more insights, visit us at csimfunds.com