American investors understand that it requires discipline to stay in the markets during good times and bad. But in practice, what exactly does that mean?
When markets go through mood swings – or, in investing jargon, become volatile – people show corresponding emotional reactions. Often, those reactions mean panicking and putting everything into cash or gold.
Unfortunately, these panic-driven responses do more harm than good, and they are terrible money decisions. For one thing, there is a transaction cost with every trade. That can cut into returns. In addition, if you are trading in a taxable account, capital gains taxes can also take money out of your pocket.
When it comes to sticking with a disciplined investing plan, American investors don’t get much encouragement from the stock-picking gurus on TV and in newsletters. Too often, a person whose job title is “strategist” or “economist” at a big bank or brokerage will go on TV, explaining why it’s tactically a good idea to move investments around, in response to whatever the market happens to be doing.
To be sure, investment advisors face pressure during market downturns. Clients see portfolio values declining, and believe there is a better approach, and say they will move to another advisor, or simply become do-it-yourselfers.
Sticking to your plan, and remaining disciplined, isn’t easy for any investor, especially during significant market declines. There are ways to make the process more tolerable, but it means sticking to a set of rules.
- Have an investing philosophy. This applies to the long haul, not just this quarter. It doesn’t mean just saying, “I want to make money,” or, more common these days, “I want to avoid losing money.” Those are not investing philosophies. An investment philosophy is pretty simple: You believe you can beat the market, however you define that. Most Americans believe the market to be the S&P 500 index, although that’s a deeply flawed assumption. The other philosophy is that you can get market returns, simply by investing in a broad portfolio of international stocks and bonds. After many years of working in the stock-trading industry, and watching people spend a lot of money on newsletters, software and conferences in an attempt to find that magic, market-beating formula, I did my homework, and realized that attaining broad market returns is the preferable way to make money, over the long term.
- Use asset class investing to implement your philosophy. This means investing in the world of securities that are available – not simply the big, American companies that we hear about all the time. Your particular allocation should be tailored for your risk tolerance, time horizon and unique objectives. It’s a strategy that you maintain over time, without making changes in response to market volatility or scary stories in the news.
- Watch your costs! Use low-cost funds to allocate into the various asset classes. This means passive investments, such as the funds we use, from Dimensional Fund Advisors. These funds offer an inexpensive way to diversify and get broad-market returns, and are better investments than mutual funds with costly loads and sales charges.
- Don’t shuffle holdings around in response to market conditions or what you see in the news. Markets go up and down. Intellectually we know this, but that doesn’t make it any easier to sit through the volatility, especially when 2008 seems like it was yesterday! While you don’t want to be trading in reaction to market conditions, you do want to rebalance on a regular basis, to keep your intended allocation in line with your plan.
- Remain invested, regardless of what the market is doing. It might feel safe to sit out downward-trending market in cash, or to refrain from investing when you believe the market is overbought. Unfortunately, these exercises in market timing typically end badly, with investors paying trading costs and making incorrect guesses about the future direction of the market.
If you adhere to this kind of disciplined strategy, you’ll start noticing plenty of noise from the “tactical” investors – those who believe in trading in reaction to whatever the news is reporting today. This kind of market timing is the opposite of a disciplined investment strategy. These market timers prey on your fears by predicting that some kind of devastating event is imminent. As a seven-year study by CXO showed, these market-timing gurus had less than a 50-50 chance of being right. Is that really advice worth following? Especially when you will never hear these fortune tellers mention their incorrect market calls!
Remaining disciplined with your investing strategy seems easy, at least on an intellectual level. It’s similar to staying healthy: We all understand the need to eat healthy foods, skip dessert, and move more, rather than sitting around. But implementing that healthy lifestyle is a whole lot more difficult!
That’s where a great investment coach enters the picture: The job of an investment advisor is not to pick stocks and time the market, but to help you stay disciplined through all manner of market conditions and economic cycles.