The stock market has gotten a little jumpy of late:
In the last week of March, the S&P 500 moved more than 2% each day for three consecutive days – the first time that’s happened in 2 & 1/2 years.
The CBOE Volatility Index (VIX), known as Wall Street’s “fear gauge,” has traded at an average of about 17 this year – a 54% increase over last year’s average of 11… a big jump that reflects a lot more uncertainty in the market.
We’ve had smooth sailing for so long, it’s a good time to review some basics on how to think about volatility and bear markets.
After all, to change the metaphor, the time to run a fire drill is when there is no fire.
So let’s start with a question: What is the most important determinant of your lifetime success as an investor?
It doesn’t have much to do with the usual things people talk about.
It’s not about being in the right funds or the right asset classes. It’s not even about being in the right stocks.
It really comes down to your own behavior – and how you respond to volatility.
Let’s say you owned Apple’s stock 10 years ago. If you put $10,000 in Apple 10 years ago, you’d have about $94,000 today. That’s almost a 10-bagger. You didn’t have to worry about Fed moves, the economy, the dollar, etc. You just had to own Apple… and go fishing.
But it wouldn’t have done you much good to buy Apple in January 2008 for $25 only to get scared out for a 25% loss in March 2008. You had to hold on.
Even if you did hold on, you would’ve looked like a dummy by March of 2009. At that point, with the stock at $12 per share, you’d have been sitting on a 52% loss.
Even if you had held it and doubled your money in 2011 when Apple shares hit $50, selling then would have been a huge mistake.
Keep in mind that Apple is $173 per share today…
So even if you happened to own one of the best-performing stocks of the last decade, you can see all the ways you could’ve screwed it up.
You can also see how this applies, no matter what you invest in. Even if you have your money in a boring old index fund, it doesn’t mean you’re immune to making the same mistakes.
You could panic and sell near a bottom, or stop investing because the market has done poorly and buy back in near tops.
Well, if it were easy, more people would be getting rich by investing.
But there are ideas to help you avoid making those common mistakes…
The Road to Wealth Starts Here
Nick Murray, a retired investment advisor who started his own advisory in 1967, is also the author of a couple of wise books on investing. (For example, see Simple Wealth, Inevitable Wealth.)
Murray preaches the idea that success has more to do with how you behave than which funds or stocks you own. Success is more about sticking to a plan and focusing on principles that work.
I recently reread his book Behavioral Investment Counseling, which is for advisors. But I’ll summarize some of the more interesting ideas and snappy metaphors.
I can’t know exactly how things will turn out all right. I just know that they will turn out all right.
Murray likes to say that you can’t be a good investor if you’re afraid of the future. You have to believe that if you follow time-tested principles, you’ll be okay.
We aim to buy undervalued stocks that have strong financial conditions and are managed by people with skin in the game. It doesn’t mean every stock pick works. And we don’t know when they’ll work. But we believe that if we follow our principles, our portfolio will do much better than our neighbors’ over time.
Stop looking at your portfolio every day.
This is simple, but plenty of research shows that the more people look at their portfolios, the worse their returns. This is probably because it makes them more likely to ditch something that has performed poorly and/or jump on something that looks like it’s moving.
If you look at your stocks several times a day, first, try to look only once a day – after the close. Then try to make it once a week. See how this changes your outlook on price changes.
Never own enough of any one thing that it could kill you if it goes south.
I remember years ago, one reader sent me his portfolio. I cringed. It was full of gold mining stocks – way too much in “one thing.”
As Murray memorably puts it: “The fewer ideas in your portfolio, the fewer bullets it will take to kill you. One idea: one bullet.”
We run a concentrated portfolio. But we try to balance our risks by owning companies in different industries that do business all over the world. No one bullet can kill us.
Invest for total return, not yield.
I see some investors – particularly older investors – focus on stocks that pay generous dividends. This is a mistake. The focus should be on total return (capital gains plus dividends), not yield (dividends only).
Murray says that a focus on dividends is like having a well, but only drawing out water that comes from snowfall and not rainwater. “Rainfall, snowfall: It’s all water,” Murray writes. As long as you draw less water than what’s coming in, you’ll be fine.”
My favorite stuff from Murray, though, is how he writes about bear markets…
A Bear Market Sermon (Or How to Love Bear Markets)
Murray has the best definition of a bear market that I’ve ever read:
A bear market is a period of time during which common stocks are returned to their rightful owners.
In a bear market, the “wise and deserving” investors pick up shares at fire-sale prices. The punters, who didn’t really know what they owned anyway, sell to them.
Bear markets are a natural part of markets. We need to expect that they will occur. There have been 13 bear markets (peak-to-trough declines of 20% or more) since WWII. That’s one every five to six years. At that rate, an investor in the market for 30 years can expect to see at least five of them.
This is the most important thing to know about a bear market: They happen. As Murray says:
People lived through these events; they remember how scary these episodes were. They just need to be reminded of how ordinary, how mundane, how quotidian crisis is – and how evanescent.
Here’s a table with those bear markets – note the durations:
|Dates of Market Peak||Dates of Market Trough||% Return||Duration
Ironically, Murray wrote his book in 2008. The last bear market in the table was still ongoing. It was only October when his book came out. His was a wise and courageous voice in a maelstrom of fear!
Anyway, don’t take the wrong lesson from this table. It’s not a prediction about future bear markets. It’s only to illustrate what they have looked like in the past. You have to learn not to fear bear markets and not to panic.
If you’re doing the right things, a bear market is just a chance to buy stocks at cheap prices. Otherwise, just sit tight and stick to your plan.
When the next bear market comes, we won’t change a thing.
I want to emphasize this point. Our principles won’t change when the market falls 30% (or whatever). I want to tell you this now, so that when that bear market comes, you’ll know what to do – which is nothing that we’re not already doing.
As Murrays writes:
Our mortal enemy is not “underperformance,” or recession, or the balance of payments deficit, or the entitlement crisis, or any other trend or event that’s taking place anywhere except between the investor’s ears. Our enemy is [our] proclivity to panic. We must vanquish the impulse, or… fail.