Stock market volatility scares many people off equities – especially in a bear market like this one.
Yet the vast majority of financial advisors agree that investing long term in the stock market is the only way an average person can secure enough capital to pay for a comfortable retirement.
To stick with equities through bad times as well as good:
To avoid it, I’d like to suggest three slightly counter-intuitive techniques to help you ride out, or ignore, volatility in your portfolio.
I’ll look at two strategies in follow up posts in this series. Today, I’d like to send you to sleep…
Strategy 1. Pick a boring online trading brokerWhether you invest through ETFs that track the markets or you buy specific shares in small growth companies, you don’t want your trading account to influence your decision making.
It’s all down to investor psychology. These brokers can damage your wealth by:
To pick one report from the mid-1990s, Terrance Odean of the University of California, Berkeley, concluded that:
The poor performance of those households that trade frequently is generally consistent with the implications of recent theoretical models of investor overconfidence. Our central message is that trading is hazardous to your wealth.
It’s worth remembering that execution brokers make their money when you trade, not when you hold. It may be in their interests to design a platform that encourages you to buy and sell more shares, even if it’s not in your own interests.
So try to avoid brokers with too many bells-and-whistles.
My ideal trading account would look like a spreadsheet from the mid-1980s. I haven’t found one as plain as that one yet, but we can all dream.
Editor’s Note: I totally agree. Boring is good in investing. What do you think? Are you a flashy trader?
Why You Should Ignore Your Portfolio for Months at a Time
Strategy 2: Try to ignore your portfolio for months at a timeEven better than a boring account is one you don’t bother checking at all. It might seem ridiculous not to watch your portfolio like a hawk, but if seeing your net worth fluctuate makes you unhappy and scares you out of the stock market, then checking your performance is counterproductive.
Warren Buffett famously implores investors to buy stocks for the long-term, and he’s done quite well. How long is long-term? Certainly longer than the horizons of private investors who check the prices of a stock they bought 60 minutes after assuming ownership. (Yes, that includes me! Editor’s note: Me too!)
Buffett once said, “I buy on the assumption that they could close the market the next day and not reopen it for five years”. Buffett is so confident in the businesses he buys that the daily fluctuations in their value aren’t a concern. I wouldn’t go that far – I’m not as sure of my ability as I am of Buffett’s – which is one of many reasons why I’m not as rich as him. But I can tell you that checking your portfolio every day (let alone every hour) is guaranteed to make you unhappy.
The reason is that while stocks, in aggregate, have always gone up over the truly long-term, their value can go anywhere over shorter time periods.
Nassim Taleb illustrates this really well in his excellent book, Fooled By Randomness. Assume, Taleb suggests, that you are investing in a market with 15% returns and 10% volatility per annum. This equates to a 93% probably of success in any given year. Pretty good odds, eh? Over shorter timescales, though, the picture is different.
Here are the chances of success with Taleb’s example investment over different timescales:
Scale – Probability
1 year – 93%
1 quarter – 77%
1 month – 67%
1 day – 54%
1 hour – 51.3%
1 minute – 50.17%
1 second – 50.02%
Personally, I find these figures really interesting. In the ultra short-term, even an ultimately successful investment is barely more likely to be up than down.
Now, Taleb asks us to imagine a fictitious dentist who checks the above investment every day.
At the end of every day the dentist will be emotionally drained. A minute-by-minute examination of his performance means that each day (assuming eight hours per day) he will have 241 pleasurable minutes against 239 unpleasurable ones.
Psychologists have shown that we feel pain from losses more than we feel pleasure from gains. Over the short-term, the pain of seeing losses from our stocks will outweigh the pleasure. The danger then is we sell out to stop the pain.
In contrast, if the dentist only checked his portfolio once a month, then as 67% of his months will be positive he’d have only four miserable sessions per year, versus eight good ones.
Checking yearly, he’d be even happier with his performance. Only in one year out of 20 would he drill unnecessary holes on unsuspecting patients to work off his anger. The other 19 years, he’d be thrilled.
Taleb’s specific investment is invented, but it is directly comparable to investing in the stock market. Most of us hold our investments for the long-term, yet we monitor their performance regularly over short periods of time, exposing ourselves to inevitable anguish.
Over 40 years of our investing for retirement, history suggests investors in stocks will do very well. Over a month, let alone a day, almost anything can happen.
So why worry too much along the way? If you’re not a stock market junkie, don’t become one.
Have faith, and keep up with regular investments. Check your portfolio once a year, where you might also consider rebalancing between the various asset classes such as stocks and bonds. You’ll almost certainly end up richer than the day trader next door.
Strategies for investing in bear markets
Strategy 3: Try to invest when the market is downThe best antidote I know for beating bear market blues is to buy when the market is down.
Averaging down can be a dirty word among traders, but value-orientated equity investors should welcome the chance to buy companies they believe in at a cheaper price. And buying when the whole market is cheaper, that’s another matter altogether.
Here you’re not chasing a bad decision in a stock as you might be when averaging down. Instead, you’re reinforcing your good decision to invest in equities for the long-term.
If you want to ensure you get the big returns from stocks that investment writers highlight when urging you to invest in equities, you need to buy during bear markets to make up for the lousy returns from those years when you buy at what proves to be the top of a bull market.
It’s true that if you could find a way to consistently get out of stocks before a bear market struck, you could forget about getting rich slowly. Wall Street would beat a path to your door!
But most investors will never manage to get out before a stock market plunge, by definition. The bull market that precedes the bear is the result of the surge of buying and optimism that overwhelms the money of those naysayers.
What too many investors do instead, is get out of the market completely after the bear market strikes. Like this, they crystallise their losses, and risk missing out on the stock market’s recovery.
According to Bloomberg, U.S. investors withdrew a record $194 billion from stock and bond mutual funds in 2008.
These investors who contributed to the worst equity market in 70 years by selling may currently derive some comfort from knowing they can’t lose any more money in stocks. But to make money from the stock market, at some point they will need to get back in.
How high do you buy?Judging when to reinvest in an under-valued market is at least as hard as selling out of an over-valued market. The risk to the investor on the sidelines is that he or she leaves it too late, and misses much of the upside from the next bull run.
A study earlier this decade by SEI, the asset manager, found investors paid a heavy price if they missed the start of the bull market by staying in cash too long.
According to a MarketWatch report, in a study of 12 post-World War II bear markets:
The painful losses will still be fresh in their memory, and they’ll worry the recovery is a temporary blip, which of course it may well prove to be. So they’ll wait until the talk of huge gains from stocks overwhelms the memory of the losses they endured during the last market fall, and finally buy in well into the rally.
Such investors think they’re being prudent, when it reality they’re amplifying their risks by eventually buying into a market that is more expensive and that offers far less upside then when things looked bleakest.
I know people who were still waiting for a bear market to return in 2005, some five years after the start of the dotcom crash and well into the next bull market.
Those who finally jumped back into the market in 2007 paid a heavy price. They have suffered all the declines of the 2007 to 2009 bear, with little of the previous bull market gains to cushion their losses.
Dollar-cost averaging your money into a broadly diversified stock market investment held for the long-term combines all three psychological tactics I’ve discussed in this series into one winning strategy:-
1) Nothing could be more boring than a regular investment into valued dividend stocks.You’re more likely to check how that paint is drying than your stocks. You’re therefore less likely to be scared out of the market because of short-term losses.
2) If you invest in long term stocks and watching your stocks gets duller stillWith a bit of luck you might find a manager who only supplies you with an update once a year. Since markets generally go up over the long-term, most years you’ll be happy to receive it.
3) Market up? Market down? No worries.When stocks are rising you’re richer, and when they’re falling you can take comfort that you’re buying more equities for your bucks. It’s a win-win situation.
Investing in the stock market will never be as easy as putting money in the bank, which is one of the main reasons why it offers greater rewards.
But by investing with an awareness of your human frailties, you can at least make investing life easier for yourself, and with luck enjoy a richer retirement as a result.
Quote of today : " If you can see the Positive sides of everything, you will be able to live a much richer life than others. Everything comes to you at the right moment. Be Patient."
Yet the vast majority of financial advisors agree that investing long term in the stock market is the only way an average person can secure enough capital to pay for a comfortable retirement.
To stick with equities through bad times as well as good:
- You need to believe in the long-term case for investing in equities.
- You need the right mindset to be put your commitment to investing in equities into practice.
To avoid it, I’d like to suggest three slightly counter-intuitive techniques to help you ride out, or ignore, volatility in your portfolio.
I’ll look at two strategies in follow up posts in this series. Today, I’d like to send you to sleep…
Strategy 1. Pick a boring online trading brokerWhether you invest through ETFs that track the markets or you buy specific shares in small growth companies, you don’t want your trading account to influence your decision making.
It’s all down to investor psychology. These brokers can damage your wealth by:
- Flashing prices changes
- Using color aggressively to show your gains or losses
- Emailing information to you about your stocks performances
To pick one report from the mid-1990s, Terrance Odean of the University of California, Berkeley, concluded that:
The poor performance of those households that trade frequently is generally consistent with the implications of recent theoretical models of investor overconfidence. Our central message is that trading is hazardous to your wealth.
It’s worth remembering that execution brokers make their money when you trade, not when you hold. It may be in their interests to design a platform that encourages you to buy and sell more shares, even if it’s not in your own interests.
So try to avoid brokers with too many bells-and-whistles.
My ideal trading account would look like a spreadsheet from the mid-1980s. I haven’t found one as plain as that one yet, but we can all dream.
Editor’s Note: I totally agree. Boring is good in investing. What do you think? Are you a flashy trader?
Why You Should Ignore Your Portfolio for Months at a Time
Strategy 2: Try to ignore your portfolio for months at a timeEven better than a boring account is one you don’t bother checking at all. It might seem ridiculous not to watch your portfolio like a hawk, but if seeing your net worth fluctuate makes you unhappy and scares you out of the stock market, then checking your performance is counterproductive.
Warren Buffett famously implores investors to buy stocks for the long-term, and he’s done quite well. How long is long-term? Certainly longer than the horizons of private investors who check the prices of a stock they bought 60 minutes after assuming ownership. (Yes, that includes me! Editor’s note: Me too!)
Buffett once said, “I buy on the assumption that they could close the market the next day and not reopen it for five years”. Buffett is so confident in the businesses he buys that the daily fluctuations in their value aren’t a concern. I wouldn’t go that far – I’m not as sure of my ability as I am of Buffett’s – which is one of many reasons why I’m not as rich as him. But I can tell you that checking your portfolio every day (let alone every hour) is guaranteed to make you unhappy.
The reason is that while stocks, in aggregate, have always gone up over the truly long-term, their value can go anywhere over shorter time periods.
Nassim Taleb illustrates this really well in his excellent book, Fooled By Randomness. Assume, Taleb suggests, that you are investing in a market with 15% returns and 10% volatility per annum. This equates to a 93% probably of success in any given year. Pretty good odds, eh? Over shorter timescales, though, the picture is different.
Here are the chances of success with Taleb’s example investment over different timescales:
Scale – Probability
1 year – 93%
1 quarter – 77%
1 month – 67%
1 day – 54%
1 hour – 51.3%
1 minute – 50.17%
1 second – 50.02%
Personally, I find these figures really interesting. In the ultra short-term, even an ultimately successful investment is barely more likely to be up than down.
Now, Taleb asks us to imagine a fictitious dentist who checks the above investment every day.
At the end of every day the dentist will be emotionally drained. A minute-by-minute examination of his performance means that each day (assuming eight hours per day) he will have 241 pleasurable minutes against 239 unpleasurable ones.
Psychologists have shown that we feel pain from losses more than we feel pleasure from gains. Over the short-term, the pain of seeing losses from our stocks will outweigh the pleasure. The danger then is we sell out to stop the pain.
In contrast, if the dentist only checked his portfolio once a month, then as 67% of his months will be positive he’d have only four miserable sessions per year, versus eight good ones.
Checking yearly, he’d be even happier with his performance. Only in one year out of 20 would he drill unnecessary holes on unsuspecting patients to work off his anger. The other 19 years, he’d be thrilled.
Taleb’s specific investment is invented, but it is directly comparable to investing in the stock market. Most of us hold our investments for the long-term, yet we monitor their performance regularly over short periods of time, exposing ourselves to inevitable anguish.
Over 40 years of our investing for retirement, history suggests investors in stocks will do very well. Over a month, let alone a day, almost anything can happen.
So why worry too much along the way? If you’re not a stock market junkie, don’t become one.
Have faith, and keep up with regular investments. Check your portfolio once a year, where you might also consider rebalancing between the various asset classes such as stocks and bonds. You’ll almost certainly end up richer than the day trader next door.
Strategies for investing in bear markets
Strategy 3: Try to invest when the market is downThe best antidote I know for beating bear market blues is to buy when the market is down.
Averaging down can be a dirty word among traders, but value-orientated equity investors should welcome the chance to buy companies they believe in at a cheaper price. And buying when the whole market is cheaper, that’s another matter altogether.
Here you’re not chasing a bad decision in a stock as you might be when averaging down. Instead, you’re reinforcing your good decision to invest in equities for the long-term.
If you want to ensure you get the big returns from stocks that investment writers highlight when urging you to invest in equities, you need to buy during bear markets to make up for the lousy returns from those years when you buy at what proves to be the top of a bull market.
It’s true that if you could find a way to consistently get out of stocks before a bear market struck, you could forget about getting rich slowly. Wall Street would beat a path to your door!
But most investors will never manage to get out before a stock market plunge, by definition. The bull market that precedes the bear is the result of the surge of buying and optimism that overwhelms the money of those naysayers.
What too many investors do instead, is get out of the market completely after the bear market strikes. Like this, they crystallise their losses, and risk missing out on the stock market’s recovery.
According to Bloomberg, U.S. investors withdrew a record $194 billion from stock and bond mutual funds in 2008.
These investors who contributed to the worst equity market in 70 years by selling may currently derive some comfort from knowing they can’t lose any more money in stocks. But to make money from the stock market, at some point they will need to get back in.
How high do you buy?Judging when to reinvest in an under-valued market is at least as hard as selling out of an over-valued market. The risk to the investor on the sidelines is that he or she leaves it too late, and misses much of the upside from the next bull run.
A study earlier this decade by SEI, the asset manager, found investors paid a heavy price if they missed the start of the bull market by staying in cash too long.
According to a MarketWatch report, in a study of 12 post-World War II bear markets:
- Investors who held their stocks through the bear market gained an average of 32.5% during the first year of recovery.
- Investors who bought one week after the market rally began saw a 24.3% return.
- Those who waited for three months before jumping back in achieved only 14.8%.
The painful losses will still be fresh in their memory, and they’ll worry the recovery is a temporary blip, which of course it may well prove to be. So they’ll wait until the talk of huge gains from stocks overwhelms the memory of the losses they endured during the last market fall, and finally buy in well into the rally.
Such investors think they’re being prudent, when it reality they’re amplifying their risks by eventually buying into a market that is more expensive and that offers far less upside then when things looked bleakest.
I know people who were still waiting for a bear market to return in 2005, some five years after the start of the dotcom crash and well into the next bull market.
Those who finally jumped back into the market in 2007 paid a heavy price. They have suffered all the declines of the 2007 to 2009 bear, with little of the previous bull market gains to cushion their losses.
Dollar-cost averaging your money into a broadly diversified stock market investment held for the long-term combines all three psychological tactics I’ve discussed in this series into one winning strategy:-
1) Nothing could be more boring than a regular investment into valued dividend stocks.You’re more likely to check how that paint is drying than your stocks. You’re therefore less likely to be scared out of the market because of short-term losses.
2) If you invest in long term stocks and watching your stocks gets duller stillWith a bit of luck you might find a manager who only supplies you with an update once a year. Since markets generally go up over the long-term, most years you’ll be happy to receive it.
3) Market up? Market down? No worries.When stocks are rising you’re richer, and when they’re falling you can take comfort that you’re buying more equities for your bucks. It’s a win-win situation.
Investing in the stock market will never be as easy as putting money in the bank, which is one of the main reasons why it offers greater rewards.
But by investing with an awareness of your human frailties, you can at least make investing life easier for yourself, and with luck enjoy a richer retirement as a result.
Quote of today : " If you can see the Positive sides of everything, you will be able to live a much richer life than others. Everything comes to you at the right moment. Be Patient."