[This blog was originally published by Summitas at www.Summitas.com]
In my last blog (“Are We Optimized for Wealth Destruction?”), I argued that investors are hard-wired for failure. I gave many examples of irrational investment mistakes that we see over and over again, especially during periods of market stress such as powerful Bull and Bear Markets. In this blog I suggest a few steps thoughtful investors might take to minimize the likelihood of irrational action and to blunt its consequences. Here they are:
● First, recognize the problem: Because we are emotional as well as rational creatures, we are prone to acting emotionally precisely when we should be acting rationally.
● Next, buy the right risk and keep it: If our comfort level suggests putting 65% of our assets in stocks, what in the world are we doing allowing that percentage to grow to 80% in a Bull Market or 40% in a Bear Market?
● Swim with a buddy: Find a friend, family member or trusted advisor – someone who’s money it isn’t – who will watch your back, playing Devil’s Advocate and holding you accountable for the emotional factors at play in your investment thinking and decisionmaking.
● Study the past: Becoming familiar with the aftermath of Bull and Bear Markets in the past will go a long way toward avoiding the “it’s different this time” mentality. It’s almost never different.
● Own flight-to-quality assets: If you are spending 3% of your capital every year, consider setting aside 9% to 10% of the portfolio in laddered Treasuries. In a catastrophic Bear Market, you will have set aside three years of spending in quality assets and at very little opportunity cost.
● Develop a crisis-management program: Decide now, while you are calm, exactly what you will do during the next period of market stress, whether that stress comes in the form of a Bear or Bull Market. Write the program down, as well as the rationale for it. Show it to your “buddy” (see above). This step can help avoid the worst consequences of greed and fear, as well as avoiding troublesome behavioral responses such as framing (mental shortcuts to ease – but often compromise – decisionmaking); anchoring (refusing to sell that loser trading at $10/share because we bought it at $20/share); and counterfactual thinking (I would have made money if only I’d bought the stock a year earlier).
Before you know it, you’ll be looking forward to the next market crisis!
Please note that this article is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.