A common theme among investors who get poor returns over the long run is that they change their investment approach whenever stocks drop sharply. This applies to those who pick their own stocks, ETFs, or mutual funds, but I see it more often with those who work with financial advisors.
It is inevitable that stock markets will occasionally drop 20% or more. We can’t predict when this will happen, but it will keep happening. It’s not your fault or your financial advisor’s fault. It’s not realistic to think you or your advisor should have seen it coming. It makes no sense to change investment strategies or advisors over something we can’t control.
When I hear about an investor changing strategies, sometimes the reason makes sense. For example, seeking lower fees or better advice or both. But too often I hear an investor complain about losses with a previous advisor and deciding to switch to a new advisor. Usually, the losses come from the whole stock market dropping rather than something the advisor did wrong. These investors are destined to bounce from one advisor to another every time the stock market drops and pay huge fees the whole way.
When you place some fraction of your savings into stocks, keep the following in mind. It is inevitable that their price will have a gut-wrenching drop at some point. There is no point in hoping it won’t happen. On average, stocks go up over time, but they drop sometimes. Get used to this idea or reconsider your asset allocation.
It's funny how people buy stocks like perfume - the more expensive, the more they buy.
ReplyDeleteIt seems that people run away when stocks are on sale. Yet, most people buy extra groceries when things are on sale. Why not keep some extra cash on hand for the inevitable sales that come on stocks?
@Anonymous: There is a cause and effect explanation. It is the people running away from stocks that causes prices to drop. So, if people thought differently, stocks wouldn't drop in the first place. But that doesn't stop a minority of people from choosing to be contrarian as you point out.
DeleteThe trouble with keeping cash on hand is opportunity cost. It allows you to buy stocks after a 20% drop, but what if the cash was sitting on the sidelines through a 50% rise prior to the 20% drop?
My approach is to leverage myself if ever there's a massive drop. Another 2008-like "black swan" and I'll be looking into the Smith Maneuver or just a plain old mortgage.
ReplyDeleteThe opportunity cost is limited and it gives me the means to profit if things go sideways on the markets.
@Anonymous: In early 2009 I thought long and hard about getting a mortgage to invest more, but decided against it.
DeleteHi Michael,
DeleteWhat if you had gone ahead with that mortgage? Would you have achieved your goals sooner?
@R: Probably, but I try not to think ex post. If I had taken out the mortgage early in the stock crash and stocks had dropped by more than they did, it might have worked out badly. I'm at peace with my decision not to amplify risk more than necessary.
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