Greece, China, Russia. ISIS. Cyber security. North Korea. Oil Prices. Stock market valuations. The Fed’s interest rate policy. Open any newspaper and it’s hard to choose which headline will be the first to knock stocks back into the red and blow up your portfolio along the way.
What is the biggest threat to your portfolio today?
Blogger and financial advisor Joshua M. Brown says that the biggest threat to your portfolio isn’t any of these news headlines – it’s you.
China is not threatening your portfolio, nor is the price of oil or the level of the Fed Funds rate. What’s threatening your portfolio is the way in which you may react to any of these items, plain and simple. Your emotions and the actions you take during times of increased volatility or drawdown will ultimately have more impact on your long-term returns than any exogenous thing that may come along.
Mr. Brown points out that in 1929, 1987, 2000, and 2007 no one was able to predict a stock market collapse – nor can we look back today even with all the benefit of hindsight and point to one single event that precipitated an entire crash. He goes on to say that it makes “more sense to recognize the durability of the capital markets in the face of all these threats rather than try to play hopscotch with our retirement assets each time a new one arises,” capping his point with the chart below (courtesy of Dimensional Fund Advisors).
Note that each item along this timeline was accompanied by thousands of articles and TV segments discussing at length how bad things were going to get…
I raise the above topic – not as any sort of market commentary on whether the bull market still has legs in it or if the market’s due for a precipitous decline – but to point out a common mistake that many investors make: allowing others (whether it’s the media, friends, co-workers, or even clients) to constantly influence their buy and sell decisions.
Managing Your Emotions
Ben Graham’s The Intelligent Investor was really more of a psychology book than it was an investing book – a behavioral finance manual decades ahead of its time. In the book, Graham says that he has “seen much more money made and kept by ‘ordinary people’ who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock-market lore.”
Sometimes, when the crowds are screaming with either fear or greed, the best strategy is to do nothing. Take your foot off the gas. Even Warren Buffett does the same thing. Robert Hagstrom, author of The Warren Buffett Way, says that “much of Buffett’s success in managing Berkshire’s investment portfolio can be attributed to his inactivity. Most investors cannot resist the temptation to constantly buy or sell stocks.”
In the end, success is determined just as much from managing your own emotions as it is from managing your portfolio. Shakespeare was, of course, right: “The fault, dear investor, is not in our stars – and not in our stocks – but in ourselves.”
Keep this in mind and you might just save yourself from your own worst enemy.