While financial planning is a journey, the investment component of the process has unique characteristics. No matter how much we plan, adjust, and optimize, at times the serene seas can turn rough.
As I’ve assimilated through my 35+ years of providing real-life investment guidance, there are specific things I do and reflect on along the voyage. This list is just that. These are the thoughts, practices, and actions that I rely on while navigating through turbulent markets. This mindset helps me zoom out at times and zoom in at others, allowing me to evaluate what’s going on during these critical junctures and position portfolios accordingly.
1. Don’t put too much focus on short-term information, like the daily news cycle.
Financial markets are complex and chaotic systems and their behavior has both systemic and random components.
Yet, psychologically humans prefer order, so we almost always search for the reason something happened. For instance, it drives me crazy when moments after a tragic event occurs, instead of acknowledging what just happened for what it was, we rush to questions like what was the person thinking? What was their motive? Why did this happen?
Similarly, when the financial markets move up or down, everyone wants to know the cause of the market movement. In turn, the financial media fights for our attention as they feature experts who come up with all sorts of possible reasons. After all, the media is in the business of grabbing and holding our attention. Unfortunately, this often leads to the reasons becoming the storyline and somehow taking on a life of their own. Inexperienced investors (and even some experienced ones) tend to think of the market in terms of certainties and the media promotes this by making things sound definitive. “This particular outcome will play out, and here’s why.”
The problem with that sort of reasoning is you immediately start to tune out alternative scenarios because you are now committed to some potentially wrong point of view.
Mindful investors should remain open to all possibilities within the markets and think in terms of probabilities, not certainties. So, rather than focus solely on the storylines propped up within the daily news cycle, I prefer to zoom out and evaluate the macro trends of the markets. I ask questions like: What is the overall trend? How does the short-term trend compare to the intermediate or longer-term trend? When various disparate data points and alternative market measures are linked and analyzed, what does the weight of the evidence indicate?
All of these questions help me zoom out and see the bigger picture while cutting through the constant buzz of the short-term, daily news cycle.
2. Moves in the markets appear completely random but they tend to repeat and often rhyme.
Whenever the next recession occurs, I don’t expect it to be the same as the last, but I do expect it to have similarities.
That’s because the financial markets are simply a synthesis of human emotions and psychology. It is key to understand that people’s relationship with fear and greed has as much impact on the economy and stock market as company earnings and interest rates.
Greed often leads people to experience the phenomenon of FOMO (fear of missing out) and as more and more investors with a herd mentality pile into a particular asset class, whether it’s the tech stocks, gold, or real estate just to name a few—this increased demand leads to higher and higher prices for the asset class. As prices rise and the number of people rush metaphorically to one side of the boat, it increases the chance of the boat rolling over and capsizing.
Even though we’ve seen this movie before, people caught up in the frenzy think it’s different this time (see #3 on this list). Unfortunately, this movie usually doesn’t end well, and yet, the scene gets played out over and over with a high degree of regularity.
The reality is, however, that US financial markets have consistently rewarded long-term prudent investors for decades. That’s despite numerous recessions, the dot-com bubble, the housing and financial market collapse that led to the Great Recession, and a global pandemic that brought the world economy screeching to a halt. As I evaluate current trends, I am always keenly aware of the impact of investor sentiment on investments and the markets.
And while I don’t expect history to repeat itself in a precise manner going forward, I do expect it to rhyme as humans tend to behave, right or wrong, to events in similar ways.
3. Usually, the average investor is wrong because they think “this time it is different.”
Those five words, this time it is different, can be a powerful force, causing any seasoned investor to take pause.
Human nature doesn’t change and although the details and circumstances may be distinct, at the core, it’s never different. As I previously outlined, fear and greed are the two primary drivers that often cause people to become emotionally charged with investing.
There has been a lot of research conducted over the past few decades showing that bad investment decisions are often associated with emotions. A study by Joseph Forgas at UNSW School of Psychology revealed that the more complex the choice and the more uncertain the subject matter, the more emotions may influence the decision. Since most investors are not aware of this shortcoming, they often make the mistake of allowing their emotions to drive their actions. When this happens simultaneously to a very large group of investors, their herd-like actions move prices.
An active approach to investing which involves going against the grain or contrary to what the majority of investors are doing is known as a contrarian investment style. “Two roads diverged in a wood, and I took the one less traveled by, and that made all the difference.” This poem by Robert Frost has always reminded me of this style of investing. While everyone is rushing down one road, a contrarian selects the other.
If it seems like everyone has been piling into an investment for some time, thereby pushing price levels so high that everyone is openly agreeing are insane, and yet, people are still lining up and piling in…this may be a good time to adjust your investment thesis and assume that prices are inflated and perhaps the average investor, who is still piling in, might be wrong. Eventually, when everyone who wants to buy has already bought, there will no longer exist an elevated level of demand from new investors, who were ultimately driving prices up to begin with. This historically has led to price declines, often sharp and painful, as there were fewer and fewer buyers.
Conversely, when a security, asset class, or the market, in general, has declined in price to a level that nobody wants in, this may be the time to start buying because eventually, as other buyers become attracted to this unloved investment, prices will rise. With many potential buyers out there, due to low levels of current demand, there are ample potential buyers who will eventually drive the price up over time.
Baron Rothschild, an 18th-century British nobleman and member of the Rothschild banking family, is credited with saying that “the time to buy is when there is blood in the streets.” Since humans are the driving force behind all financial assets, through supply and demand, the price pattern construct will never change. The same rules that were in force hundreds of years ago are still at work today.
Despite all of this, the stock market has still been a reliable wealth creator for decades upon decades. So if someone says this time is different, I validate that they’re probably right—this decline won’t look like the last—but it likely won’t be the end of financial markets as we know it. Financial markets and the global economy are resilient and have proven that over the long run.
4. Don’t let your opinion of what you think SHOULD happen in the market or economy bias your investment management strategy.
Just because I think something should happen doesn’t mean it will. I often reflect on what Jesse Livermore said: “Markets are never wrong—opinions are often.” Despite the fundamentals of investing, investors are human, and humans tend to lead with their emotions. That’s why the recent Gamestop (ticker: GME) stock run-up is so confusing and yet makes so much sense at the same time.
GME’s business fundamentals did not change when it went from trading at $18.84 per share to $325 per share in a month. A large group of individual retail investors took on Wall Street and put a squeeze on short-sellers resulting in the stock price skyrocketing. While this unusual event made headlines and I made a video about it here, the amazing thing is, that the price of GME shares remain elevated over a year later. What started as a short-term stock move, somehow resulted in changing investor sentiment toward the stock. Like Gordon Gekko said in the 1987 movie Wall Street, “perception became reality.”
So despite what you think should happen with a particular stock, asset class, or the overall market, the aggregation of buyers and sellers determine the price or value of securities and markets from moment to moment. Therefore, the collective perception of value may not always match yours, in the manner and at the price level that you think it should.
5. If values don’t make sense, then it might be best to not participate. Sometimes doing nothing (holding cash) is the best investment.
At the recent Berkshire Hathaway shareholder meeting, Warren Buffett berated Wall Street for promoting speculative behavior and active stock trading, particularly with stock options, effectively turning the market into a “gambling parlor.”
Buffett is famous for intentionally holding large sums of cash and patiently waiting for prices to arrive at a level he’s comfortable with. Sometimes, this may be the best course of action when markets are overvalued, and most investors are acting like short-term speculators, driving stock prices up. But patience and waiting are tricky things to do when you’re investing. However, as hard as it can be, it is critical to realize that sometimes doing nothing is the best investment.
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