Swedroe: Keep Calm And Step Forward

January 13, 2016

A good friend, Sherman Doll, related the following story. Sherman has been a two-line sport kite flier for years. While not a pro, he has learned a few tricks from observing the flying behavior of these kites. He told me that one of the most difficult skills for beginners to master is what to do when their kite starts to plunge earthward.

The natural, panicky impulse is to yank backward on the lines. However, this action only accelerates the kite’s death spiral. The effective, kite-saving technique is to calmly step forward and thrust out your arms. This causes the kite’s downward acceleration to stop, allowing you to regain control and end its plunge. What does this have to do with investing?

2016’s Grim Beginning

As you may already have observed, 2016 got off to a bad start for equity markets around the globe. In fact, for the S&P 500 Index, the first five trading days were the worst-ever start to a year, with a loss of 6%.

Combined with the weak performance of global equities in 2015, and all the geopolitical turmoil in the world, the stomachs of many investors started to rumble, especially upon hearing pronouncements from market “gurus” forecasting doom and gloom.

For example, George Soros is predicting a crisis similar to the one we had in 2008, with problems in China being the trigger. And it certainly doesn’t help when respected investors such as Jeremy Grantham and Carl Icahn are proclaiming that the market is vastly overvalued.

Over the 20 years that I’ve been providing investment advice, I’ve learned that when we have situations like the one we’re in now, many investors begin to “catastrophize.” They begin to focus solely on the negative news—such as ignoring the 292,000 increase in employment, along with an upward revision of 50,000 to the prior month’s gains, reported on the fifth day of trading in 2016. These investors begin to anticipate everything that could possibly go wrong, and end up in a loop of worry and anxiety that leads at best to indecisiveness and at worst to panicked selling.

Now, returning to my friend’s story about flying kites …

Just as when a kite starts to plunge earthward and the natural, panicky reaction is to yank backward on the lines, the natural, panicky reaction to a dive in your portfolio’s value is to pull back (sell). In both cases, pulling back is the wrong strategy. The right strategy is the less intuitive one. It involves the choice to remain calm and step forward (actually buying stocks to rebalance your portfolio back to your desired asset allocation).

Buffett’s Advice

Warren Buffett is probably the most highly regarded investor of our era. Read his statements carefully regarding efforts to time the market:

  • “Inactivity strikes us as intelligent behavior.”
  • “The only value of stock forecasters is to make fortune-tellers look good.”
  • “We continue to make more money when snoring than when active.”
  • “Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”

And finally, Buffett recommends that if you simply cannot resist the temptation to time the market, then you “should try to be fearful when others are greedy and greedy only when others are fearful.”



 

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