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You need a plan, not predictions or platitudes

A surfer contemplates the turbulent seas, just as we must plan for turbulent markets.

When stock markets slump, people pay attention.

In some ways that’s a shame, because falling markets are as normal as rising markets.

Stock markets that go down faster than they went up are perfectly normal, too.

A stock market slump is therefore literally unremarkable.

But we’re human. We evolved to take an interest.

Our instincts run on fast-forward, even if our wiser slower brains try to press pause and ponder.

The price of admission

When markets fall, some panic and consider selling. That’s natural.

Others act brave, rub their hands, and boast about it being time to buy – to be greedy when others are fearful.

That sentiment is right, and they can sound like bold geniuses.

But how long were they sat in cash, waiting for the moment to get back in?

If you buy equities when they drop 10% but you missed the previous 50% rally, you’re not being greedy when others are fearful.

Not in the bigger picture.

You’re actually being timid when others are stoically betting on the long-term propensity of stock markets to rise over the long-term.

And you’re probably going to be left poorer compared to someone who is less cunning but more pragmatic.

The price they pay for their long-term gains is not feeling as smug as you when the market does swoon. They have to take their lumps.

Usually that’s a price worth paying.

Molehills and mountains

Investing is a marathon, not a sprint.

When markets fall you can feel like Indiana Jones, running down some corridor with the precious prize in your hand – but with a boulder thundering behind, threatening to squash you.

But that’s only one scene of the story.

A better movie metaphor might be The Lord of the Rings.

I’m thinking of that montage scene where three members of the Fellowship are shown galloping across at least three mountain ranges as part of their continent-spanning quest.

The heroes go up one peak, but right ahead of them is a march down the other side.

If the Fellowship had thrown in the towel at the bottom of one of those valleys then the ending would have been very different.1

Investing is likewise – at best – a long march through peaks and troughs.

Hopefully you’re heading higher overall. But it’ll be a long time before you know for sure, and you need to be careful not to end up in a hole when your time runs out.

Otherwise it’s two steps forward, one step back – and repeat.

You knew this was coming

Fresh comments appear on old Monevator posts when markets fall.

  • “I’m re-reading this post to remind me why I’m invested this way.”
  • “I thought I was ready for a hit but I have to admit it hurts.”
  • “This is my first real experience of falling off a cliff and to be honest…I feel alright really…”

It’s humbling to think we’ve built a site that people come to when they feel unnerved by investing.

It’s great too when another reader replies with some sensible words. That means we’ve built a community.

My co-blogger The Accumulator is always more alert to these sorts of emotional shifts than me.

He suggested I write a post reassuring readers about investing through tough times.

I suppose this is my attempt, but it might not be quite what he was expecting.

If you look around the Web you’ll find plenty of pundits saying this latest correction was overdue, or the slump is overblown, or that it’s a buying opportunity, or that in a year it’ll be forgotten.

Perhaps. Nobody knows. Not just in the short-term – we all understand such volatility around here – but also in the long-term.

We make our best guesses and we build diversified portfolios that can hopefully withstand those guesses being somewhat wrong.

But we never truly know.

All over in a flash

I’ve lived through a few of these stock market storms, and they can still surprise me.

Regular readers will know I’m an active investor for my sins, despite my believing in the gospel of passive investing (we can discus why I’m active some other day).

I’m used to choppy asset prices, and to an extent I seek it out.

Yet on what they’re already calling the Black Monday of August 2015, I was newly dumbfounded.

I had cash ready to deploy into certain US companies, if I could get them at the right price.

So I waited and watched the US markets open – only to be left open-mouthed as the prices of huge firms like Apple, Facebook and Visa fell 10% or more on the off.

It was almost what I’d been waiting for. Yet I did nothing.

Why?

Because it was almost but not quite what I expected.

The deep price cuts were too much, too mad, too crazy.

I was shocked.

I remembered the financial panics of 2008 and 2009 and I wondered if I’d misread the situation. Was it happening again?

This moment seemed to last for an age as I dithered over whether to buy.

Then suddenly prices reversed and began speedily climbing (which seemed equally strange) and a company that I might have bought at 5%-off now seemed expensive at 7% lower – because 30 seconds ago it had been 15% down!

This craziness lasted barely five minutes in total, and by the end I’d bought … nothing.

So much for the bold old investor!

Cliff notes

That’s what markets do. They surprise you and unsettle you.

In response to the reader’s comment about falling off a cliff, another Monevator regular said: “This isn’t a cliff.”

And he’s right, according to the history books. Markets have fallen much further than 10%.

But perhaps for that reader, it was a cliff – even if statistically a 10% fall is nothing to write home about.

You’ll know when it’s a cliff for you when you feel it in your stomach.

Prepare yourself for a normal 10% correction and you’ll not be prepared when markets fall 20% or 30%.

Prepare for that and you’ll still feel sick from a 50% plummet like we saw a few years ago.

Been there, done that?

Perhaps they’ll fall 80% in our lifetime.

Who knows?

This uncertainty is paradoxically why equities can be expected to return more than cash over the long-term.

People hate this uncertainty, they hate the random plunges and swoons, and they hate the long periods where you feel like you’re banging your head against a brick wall for getting into shares instead of saving into cash, buy-to-let property or premium adult phone lines.

As a consequence, people under-invest in shares, and they over-invest instead in cash, bonds, and property.

And so most of the time those of us who do bite the bullet and buy shares get rewarded with superior gains over the long term.

Most of the time – but not always.

Expect the unexpected

If the volatility of equities was truly predictable – if a 10% correction did come along every 10 months, or whatever the statistics imply – then nobody would be too concerned by it.

Perhaps you’d book your holiday to coincide with the falls, and avoid all the fuss entirely.

But that’s not how markets work.

Markets do things like go up when the news is relentlessly terrible for years – and then plummet on a blue sky day.

Or you’ll have heard that shares “climb a wall of worry” and so you’re happy because everyone seems scared – and then the market crashes anyway, right in the face of that fear.

Or shares fall hard like in 2000-2003, and so people talk about a once-in-a-generation cratering – and then they crater again just a few years later.

That’s only once in a generation if you’re a gerbil with great grand kids.

The truth is you don’t know what shares are going to do. You just don’t.

You might think you do – that you’re girded for the long-term returns and for short-term volatility – but then, say, the whole world turns Japanese for three decades and even after dividends you barely break even.

Do I expect that to happen?

No.

But it might.

Known and unknown unknowns

  • Nobody expected interest rates to be held near-0% for six long years.
  • Few expected super-safe 10-year government bond yields to wallow below 2% – or to turn momentarily negative in Germany.
  • Newlywed home buyers in Tokyo in 1989 did not expect to be underwater 30 years later.
  • No gold bug expected the metal’s price to fall under $1,200 back in 2011 when gold was hitting new all-time highs above $1,800.

The subsequent fate of these surprising outcomes is misleading.

After a few weeks, months or years, they lose their power to shock and we come to accept what happened as just another data point.

They seem less scary then, and we return to believing we know what’s going on.

But do we?

Something else we don’t expect is already waiting in the wings.

Back yourself

You don’t need predictions from a talking head about where the market is going to go in the next six months.

Nobody really knows is the fact of the matter.

Deep studies have proven that rules of thumb for forecasting the market don’t work.

In general, some people are just better at talking like they know what’s going on than others – especially if they also happen to have been lucky recently.

Equally, you don’t need me to tell you to stick to your volatile equity allocation because the stock market will come good in the long term.

You need to be able to find that voice for yourself.

I love it when a plan comes together

The reality is you cannot be certain that even a well-diversified All-Weather portfolio will eventually deliver the returns you expect it to.

If you’ve done your planning properly then the chances are it will.

But it might not.

You have to understand that investing is the ultimate example of our brain’s capacity to anticipate the future and contemplate uncertainty (as opposed to living on your monkey brain’s fight-or-flight wits) but also that to prepare for the future is not to claim to predict it.

You need to create a financial plan that reflects this reality. Take your time.

Your plan should be:

Beyond that, it’s your plan, and it needs to be specific to you.

Whatever it becomes, you need to be able to stick to your plan when times get rough.

Not because things might not be rough for a reason – who knows, the boat might well be sinking – but because it was your best, most rationale, most well-considered plan that you devised on a calm day when you were thinking straight.

The chances are that if things now seem rough enough to give you second thoughts then you’re also being emotional.

That will play havoc with your perceptions and decision making abilities.

Better to act dumb.

What have you signed up for?

Lash yourself to your plan like Odysseus had his men tie him to his ship’s mast.

That way you should avoid throwing yourself into the sea.

Why not stuff your ears with metaphorical wax if you’re a passive investor, too?

Odysseus had his men do that, so they avoided the sirens’ song altogether2.

Treat your investing like you buy your house – just get on with it, month in, month out, and don’t panic at every headline.

When I asked my co-blogger how he was doing during the last wobble, he told me that he was feeling fine, but that it might be because he hadn’t actually looked at his portfolio for several months.

Months!

Is that wise? It’s at least worth thinking about.

His investing runs automatically. It will go on like a robot slave, shunting money from his bank account to his diversified passive funds regardless of his opinion about the front page of the Financial Times.

It will throw money into the abyss if it comes to it.

Some will say that’s madness. Others will say it’s the height of passive investing wisdom.

I say it’s a plan. It’s his plan, and that’s why he can stick to it.

What’s your plan?

  1. Assuming Gandalf didn’t turn up again with those elephant-sized EasyJet eagles to airlift them to their next destination. []
  2. A precaution Odysseus skipped over himself, presumably for the sake of a good story []

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{ 62 comments… add one }
  • 51 Topman August 28, 2015, 6:37 pm

    Are we not back on the discussion we had recently about the vagaries of the Chinese stock market; its very high proportion of retail investors and their propensity to panic, herd-like? Perhaps, other markets will progressively “work the Chinese market out”.

  • 52 The Investor August 28, 2015, 7:08 pm

    @david — It’s fine to discuss different points of view here but can you dial down what’s IMHO the aggressive tone please?

    It doesn’t make for pleasant reading, distracts from your argument, and is not conducive to encouraging comments from others.

    Thanks!

  • 53 Jaygti August 28, 2015, 7:31 pm

    I’m not really sure what happened to me over the past week or so. I was either timid or greedy.

    I’ve had a fair sized lump sum sitting in my sipp since march, but I’ve never really seen a good home for any of it, as every thing seemed a bit pricey.

    I invested a very small amount during the Greek crisis, but this was the moment I’d been waiting for.

    On Monday I invested about 10% of the lump sum in various trackers just in case, and waited for the stock markets to fall further before I invested some more……

    So I’m still left with most of it just sitting there doing nothing.

    As I write this I actually think it was timidity that stopped me as I would have been disappointed to have lost a lot on something that I had only just put money into.

    Happily this problem shouldn’t happen anymore as this tax year onward I’ll put enough in my sipp each month in the correct allocation so I won’t have to dump a lump sum in to get out of the 40% tax bracket every march.

    By the way great site,and comments everyone.

  • 54 Andy@Tacomob August 29, 2015, 4:11 am

    @ David
    Hi David, thank you for taking the time to critically analyse my apparently too brief and misleading line. My bad.
    I should have mentioned it as follows:

    “Whoever held shares for minimum 15 years in the US stock market, would have never made losses (adjusted for inflation by the consumer price index and dividends re-invested). And this goes theoretically back to 1870 (using the methodology of the S&P 500; in 1870 there were only 10 stocks in the index).”

    You are also correct that Japan is an outlier. For me that rapidly ageing country with zero population growth in the last 15 years classifies as the exception to the rule.

    That post of mine you quoted from begins with: “Warning: Don’t read on when you are 40 years and above!” So that “long term upwards trajectory” is over 25+ years.

    We can’t predict the future and we definitely cannot simply extrapolate the past. Nevertheless to calm our emotions we can learn a lot from history. We just can’t take it too far.

    I strongly believe that investing is more about patience and discipline than timing and hectic moves (of course always being prepared for the occasional Black Swan Event by keeping some Put Options).

    Thanks again, David, highly appreciate your comment.

  • 55 PC August 29, 2015, 11:28 am

    My plan, if you can call it that, is to look at some very long term charts on a log scale, for a bit of context

  • 56 The Accumulator August 29, 2015, 7:56 pm

    @ Tim G – too right about so-called diverse equities. When there’s trouble oop markets, correlations tend towards 1 and equities tend to be highly correlated most of the time anyway. It’s only really your bonds that tend to rock when equities roll. Gold generally uncorrelated but like you I don’t have anything to do with it nor commodities – no evidence of long term return and plenty of problems with available products when it comes to commodities.

    @ Jocelyne – One way to look at emerging markets is: if you thought they were a good deal before then they are even better value now. But another way to look at is: they are highly volatile – even more so than developed world equities – so perhaps not ideal for an investor’s first dip into the market. Take a look at the Vanguard LifeStrategy funds – they do include a small slug of emerging markets for diversification but not much.

  • 57 The Accumulator August 29, 2015, 7:57 pm

    Btw, love this thread – so good to read about everyone’s experiences and am enjoying the mutual support vibe.

  • 58 Investing Tortoise August 29, 2015, 11:18 pm

    @The Accumulator, yes, I am really enjoying this thread too.

    I like the idea that you don’t check your portfolio for several months at a time. I am not quite that good. I value mine once a month when deciding what to do any spare money from my salary, after my bills have been paid. (I am still in the accumulation phase.)

    For many months now I have been directing my saving into risk free assets. This month when I do a valuation over the long bank holiday weekend, I think it will be going into equities (via a cheap tracker of course), as my equities will probably be below weight. This allows me to re-balance on the go each month.

    Having just look at the markets over the last month I doubt I will need to do more than that to re-balance towards my chosen allocation.

    I definitely agree with having a plan and sticking to it and don’t worry about the bumps in the road, it is sage advice.

  • 59 John B August 29, 2015, 11:55 pm

    Am I right in thinking that any plan needs to include keeping all transaction details? For dividends the income tax return preservation period is short, but for capital gains I guess the period could be infinite. HMRC guidance is not clear for CGT.

    I try and keep things for the lat 7 years, and even though I do quite few transactions a year this becomes quite onerous.. Do they require printed contract notes/tax credit statements, or would they ask the companies involved if you gave an outline? How do active traders cope?

  • 60 Topman August 30, 2015, 11:01 am

    @John B

    As a retired finance professional, experience shouts at me, “keep or weep!” 🙂

  • 61 The Accumulator August 30, 2015, 11:17 am

    @ Investing Tortoise – sounds like you have a good system that works for you. Have discovered that the less I look the happier I am. It had to be a conscious decision though. I had to train myself to feel like I was letting myself down if I look. Equally I reward myself by internally praising my the ‘strength of my willpower’ if I resist a peek. I’ve gamified not looking I guess.

    @ John B – I keep all contract notes, download statements every 6 months and note transactions in a spreadsheet. Agree that it is painful – I inevitably seem to end up doing it with bloodshot eyes late at night or on a blissfully hot Sunday afternoon when I should be out playing 😉

  • 62 The Accumulator August 30, 2015, 11:19 am

    @ Tim G – good piece on equity correlations going to one: http://awealthofcommonsense.com/when-correlations-go-to-one/

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