Last week we had the referendum heard round the world. Voters in the United Kingdom turned their backs on the Continent after 43 years.
Investors worldwide were fearful and fled equities in droves. In two days the Dow Jones Industrial Average fell 871 points.
And then a strange thing happened. Investors decided that perhaps the sky was not falling after all. Counting a one day run up before the vote, in just four trading days, the Dow had nearly returned to its level of the week before. By the fifth day, it was actually 100 points higher.
This is yet another lesson that investors should not react rashly to emotional events. In the short run, markets are highly unpredictable. Study after study going back a century has shown that investors are likely to hurt themselves by quickly reacting to events and trading emotionally.
The research firm Dalbar has shown that current investors receive about one-third of the return of the mutual funds they invest in because they make ill-timed moves in and out.
It feels uncomfortable to sit there and do nothing while the world is falling apart. But do it anyway. Your wallet will thank you.
The Three Dangerous Times
The three particularly dangerous times for investors: when markets go up, when they go down and when they are flat.
For the last two years, U.S. markets have been in a narrow trading range. Some days the market is up a lot, some days it’s down big. But overall, for two years the broad market is close to flat — up 3 percent a year — a third of the long-term average.
During a long flat period, investors get bored and are often up to mischief, searching for alternatives that promise much and mask danger.
In bear markets — the market often plunges quickly –and investors are prone to panic and do things that imperil their finances for many years.
When the market is doing well — bull markets — people get exuberant and overconfident and may take on greater risks and obligations than they intend. This sets them up for failure in the next cycle.
Given this bleak picture, what should investors do to improve their odds of success? Investors need to be patient, avoid emotional decisions and think long-term.
None of this is easy but it’s important for a successful investment experience.
The U.S. stock market is off to its worst start ever — down nearly 12 percent in just three weeks. Standard & Poors searched records back to 1897 and couldn’t find anything worse.
While the market has been drifting lower since summer — including a brief but scary decline in late August — this drop has seemingly come out of nowhere and is unremitting in its furor.
Yesterday, the Dow dropped 550 points by midday before rallying sharply. While there are always things to worry about, this seems to be the bear market about nothing.
The Chinese economy, the second largest in the world, may be getting unhinged. And the oil market has gone from boom to busted in 18 months but hey, nobody’s perfect.
If it weren’t for these minor issues, the outlook might seem bright. Job growth has been strong in the U.S. and corporate balance sheets are in the best shape in years.
Worldwide, corporations and investors are awash in cash and looking desperately for places to stash it (no place more frantic than Colorado where legal marijuana growers can’t access the banking system).
So what’s an investor to do? It’s usually best to hunker down and not panic. And if you feel like panicking, turn off the TV and the Internet and take a walk. You’ll feel better and in the long run, your portfolio will thank you.
Index Funds have attained a near untouchable status among the financial press and investors. And for good reason. The funds — at least the highly diversified ones — are regularly among the top long-term investments. Recently, a Bloomberg article took an opposite tack, bashing index funds for being mindless machines that let nimble investors exploit their announced intentions. The article is harsh but accurate. Index funds are predictable and not perfect investments but they do serve many investors well. There are approaches that take the index funds as a useful starting point, attempt to preserve what’s good and enhance returns by avoiding some of the index fund flaws. Trading is one significant area. Index funds buy and sell holding whenever an index changes essentially letting the marketplace know what you are going to trade before you do it. A more patient approach to trading can lead to significant gains. For the rest of the gory details, here’s the link to “Can you really game index funds?” http://www.bloombergview.com/articles/2015-07-07/can-you-really-game-index-funds-
Like Mining Low Grade Ore
Most investors look for a big strike, a huge vein of ore. It’s always possible that they will find it but the odds are heavily against them.
Successful investing is more like mining for low grade ore. It’s a less exciting, methodical process that takes a long time. But with careful attention to strategy and execution, the probability of success is much higher.
Working with low grade ore isn’t as exciting and you’ll never have one of those “Eureka” moments. But neither do you have the frustration of one barren mine after another.
Investors look for the magic stock or the magic fund, a lottery ticket, that will bring them quick riches. In practice what works is a long-term, diversified portfolio with careful attention to minimizing taxes, watching costs and removing emotion from the process.
Those who react to the latest news or are constantly on the lookout for a winner fly in the face of decades of market history. While there is a logic and temptation to that approach, nearly all academic literature belies this notion.
Once in a blue moon, investment lightning strikes. Do you want to put your future on the line with those odds?