How to Invest in Uncertain Times (part 1)

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The market has been rocked. In the last two weeks (March 3-16, 2020), the S&P 500 has lost over 22% of its value. It’s the fastest 20% descent we’ve ever seen, and no one knows exactly where the bottom will be (or if we’ve already hit it). The market has moved in percentage multiples, both up and down, every day last week, an incredible level of volatility. The leading cause, which still feels surreal, is the propagating Covid-19 virus which has led to mass closings and increasing restrictions. Suffice it to say, it’s been a crazy couple of weeks.

In many ways, we’re in uncharted territory, which means we’ve got questions, like how are we supposed to respond to all of this? What’s the right thing to do when we’re confused about what’s happening? To add some clarity, I’ll offer up a few investing principles throughout this week.

 

Market timing doesn’t work.

  • No one knows what the market will do tomorrow. Many make predictions, but no one really knows. Don’t try to guess where the bottom is, or when we’ll hit it, or when to pull money out of the market, or when to put the money back in. The market is efficient.
  • Let’s say you really want to get out of the market because you don’t believe we’ve hit the bottom yet and you’re not interested in sticking around to find out. In order to successfully time the market you have to get two bets right: you have to get out of the market before it hits the bottom, and you have to get back in at or very near the bottom. The odds are not favorable.
  • A market study conducted at the University of Michigan measured returns from 1963 through 2004 (a period of 42 years). They found that 96% of the positive returns over that period came from 0.85% of trading days (90 out of 10,573 total trading days).
  • Another study done by A. Stotz Investment Research observed a 10 year period, from November 2005 through October 2015. After running the data through several simulations, they concluded that if you missed the 10 best market days over the specified 10 year period, you would stand to lose, on average, 66% of the gains you would have captured by staying in the market.
  • When the market moves up, it moves up quickly. Whenever your money is on the sidelines, you risk missing some of the best days the market has to offer. So stay invested, don’t panic, and anticipate the rebound.

It’s a Rough Day in the Market

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As I write this on March 9, 2020, market indexes across the board are down, some by as much as 9%. Coronavirus has made the market skittish enough over the last few weeks, to compound things Saudi Arabia announced massive cuts to the price of oil this morning, which actually seems kind of great (lower gas prices!), but markets have not reacted kindly. The response feels like panic. It’s certainly a bad day in the market, but I want to provide a little bit of context for all of this.

 

Here’s what you should know:

  • Unless you know the future or have inside information (unlikely, and illegal to trade on), you should be a long term investor. Short term market moves are pure gambles, and most often end up hurting investors. Don’t move money based on fear, which is all we hear in the news, especially on days like today.
  • Despite what pundits may be saying, no one knows what the market will do tomorrow. No one knows where the bottom of a downturn is, no one knows how long it will last or how quickly the market will come back. Don’t panic with your money, especially when the market is down.
  • Bad market days have happened before. On Black Monday (October 19, 1987) the Dow Jones Industrial Average dropped 22.61%, in one day! In order to crack the top 20 bad market days the Dow would have to lose 7%, but even if that does happen, we’ve seen the market bounce back from far worse.
  • The market bounces back quickly. When the S&P 500 loses 10% or more it recoups all losses within an average of about 4 months. The worst thing you can do is move money when the market is down and miss the bounce-back.
  • A limited number of great days in the market account for most of the great returns. A 20 year period between 1998 and 2018 included 5,040 trading days. If you missed the 30 best market days out of the total 5,040, you would have ended up with a slightly negative return over the 20 year period, $10,000 would have turned into less than $9,000. We don’t know when those great days will come (though we know they often follow bad days) but we definitely don’t want to miss them by being out of the market.
  • Markets move, but the general trajectory is up. If you’re invested for the long haul and you understand your risk tolerance, bad market days are no problem. They don’t even have to be stressful.

 

Here’s what you should do (or not do):

  • Don’t panic. This is not the first time we’ve had a bad day in the market and it won’t be the last. The worst thing you can do is move your money out of the market. In fact, bad days in the market are a great time to invest more.
  • Make sure you understand how and why you’re invested the way you are. The market will sustain losses, but an un-diversified portfolio stands to lose a lot more. On the flip side, a well-diversified portfolio can put your mind at ease.
  • Make sure your diversified portfolio has a systematic way of rebalancing. When the market is moving, a system for rebalancing will ensure that parts of the portfolio that are doing well are sold, and the parts that are down are bought. It’s an automatic ‘buy-high-sell-low’ feature.
  • Work with an investor coach. When things look bad, all the news and information surrounding you will only confirm your worst fears. An investor coach will keep you disciplined, make sure the accounts are rebalanced, and will ultimately guide you through turbulent markets to a successful outcome.

You should give board games another chance

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We’re all humans, right? We have these incredible senses of touch and sight and hearing and tasting (is there one more?). We also thrive in community, when we talk to other people and interact with each other. What better way to combine all of these human things than to sit down with some friends or family in front of a board and some little pieces of plastic?
One of our greatest temptations today is to turn to our technology instead of engaging with other people. Our phones are some of the most helpful and useful pieces of technology ever invented, but unfortunately, they can also inhibit the things that make us human.
A helpful category for thinking about this is to distinguish between rest and leisure (which I have shamelessly hacked from The Tech-Wise Family by Andy Crouch, a really helpful read). Leisure is mindlessly scrolling through social media or news on your phone, playing some kind of video game by yourself, or maybe worst of all, watching reality TV. Leisure is fine, but ultimately not all that helpful. It puts you into a sort of trance, you lose track of time, you’re probably more stressed when you quit, and you haven’t achieved anything except to waste some time and feel more harried. Rest, on the other hand, is restorative. Restful activities typically engage your mind instead of putting you into a coma. They include things like reading a book, conversing with close friends and family, playing an instrument, fishing (obviously), working out (it might take a few weeks, but once it becomes a habit it’s the best), building Legos, or playing a board game. An interesting note here, leisure activities often involve screens, restful activities often don’t.
As I write this we’re in the thick of the holiday season, Christmas hits this week, we’ll celebrate the New Year next week. Most of us will be spending at least some amount of time away from work and with family. Take the opportunity to enjoy a board game together. Engage your mind, indulge in some conversation, enjoy the people in your life. If my reasoning holds up, you’ll feel much better having done that than to have entered your trace space. We’re humans after all.

There are only two ways to invest (part 3)

 

carolina-pimenta-J8oncaYH6ag-unsplashSo there are two basic strategies to invest, and your first decision as an investor is to decide which road to take. In part 2 we talked about the active option, in part 3 we’ll cover the alternative option: passive investing.

Whereas active investing feels right, passive investing is a little counter-intuitive. You actually don’t have to do anything to be a successful passive investor. You should probably have an understanding of how the market works and have a conviction about why you’re investing the way you are, but as far as activity goes you’re taking it real easy.

One of my favorite analogies for passive investing is salmon fishing. Salmon fishing is not sport fishing, it’s almost like harvesting, like work. The importance is not in casting and reeling (a staple of sport fishing), the importance is in how well you’re set up. You need to have varying types of bait at varying depth of water, you might try variations in boat speed, variations in direction, variations in water depth, etc. The important thing is to be equipped to catch a fish at any moment by diversifying your offering as much as possible. Once you’re all rigged up, you sit back and let the market do its work.

The basic question here is about whether or not you’re confident in the fact that the market is efficient. If you believe the market is efficient (which data supports) any attempt to outperform the market by actively picking stocks or timing the market is vain. Instead of spending time on all different types of analysis and market trends, the focus can be on how to design the most efficient portfolio possible, how to diversify in the best possible way. Instead of trying to bet and predict the market, you simply need to own the market as efficiently as possible. It’s an entirely different game.

Passive investing is a wonderful thing, it reduces a great deal of stress. A poor year of returns is simply a result of the market, it’s not the result of some poor guesses by you or anyone else. A recession is no longer terrifying because you’re well-diversified and you understand that the market always bounces back, that the average market downturn lasts less than a year. Your retirement is no longer a question of ‘if,’ but of ‘when.’ A passive investor is free from analyzing endless piles of company data, the uneasiness about the market sectors they’re invested in. Passive investors don’t have to worry about how the riots in Hong Kong, or Bolivia, or Lebanon, or Iraq will affect their portfolio. It’s an entirely different way of being.

So the first decision you’ve got to make as an investor is whether you’ll be active or passive. That’s certainly not the last question you’ll have to answer, but it’s a very important one and one that set the direction of your investing journey and your financial future.

Fishing and diversification

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I love salmon fishing. I love all sorts of fishing, but salmon fishing is special. Instead of the romantic image of fly fishing in a river, or the flashy idea of big-time bass fishing, or even the nostalgic memory of fishing off a rowboat with your grandpa, salmon fishing is more like a battle. Forget everything you know about traditional casting and reeling, salmon fishing involves rigging up multiple fishing rods, attaching them to downriggers and various mechanisms for getting the lures down deep, and a slow troll on open water. The key to catching fish has nothing to do with technique or sport, it’s about setting a broad array of bait covering many different depths. We call it a ‘spread.’ If you only had one or two rods you’d be poorly served, it’s simply not a sufficient level of depth diversification. Ideally, you want 8 to 12, or even 15 to 18 in the case of professional charter boats. Here’s a quick visual:

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Notice how the lines are prudently spread across varying depths? Investing is the same way! Stick with me here; the water is the stock market, the lines/rods are investment dollars, and the different depths are asset classes. We don’t know which depth, or depths, will produce fish, we just know the fish swim all over the place and that if we’ve got a good spread (lines at different depths) we’re bound to catch something. Same with asset classes! We know that they all perform over time, but we don’t know which one is going to hit next year or which one will be best over the next 5 years. So we own all of them. Imagine how dumb it would be to have one line out in the water trolling for salmon, it makes no sense. Even if that one line is set at the depth that has produced the most fish over the last few weeks, it still doesn’t make sense. Fish move around all the time, why would you not want to cover the whole water column/stock market? Just like downriggers and multiple lines ‘enable the whole water column to be covered when trolling,’ diversification allows you to own the whole market when investing! No guesswork, no hoping, no predicting, no gut feelings, no casting lots, no anxiety, just well balanced, widely diversified investments. I’m not saying it’s easy, salmon fishing is a lot of work, but when you’re eating your salmon dinner at the end of it, you’ll be glad you diversified.