Weathering Rough Financial Seas

by | Aug 31, 2009 | Weekly Column | 2 comments

missing the boat I read a great article last week in the London Times. The title alone was an excellent piece of investment advice: “Waiting For Calm Seas Means Missing the Boat.”

The article noted that many stock markets around the world are up 50 percent from their March lows. Since an annual return of 8 percent is a fair return, the equivalent of six year’s returns has been crammed into the last five months.

This was predictable. On March 12, three days after what proved to be the bottom of the recent fall, I gave a webcast to my clients imploring them to stay in the markets and not miss the rebound. I explained that most bear markets are up 78 percent in the first three years after the market bottom, and that 50 percent of that recovery happens in the first six months. If those statistics hold, we have seen two-thirds of the entire return one could expect to receive for the next three years.

Says the Times, “Those who stood on the sidelines and missed this mini bull market will be lucky to see such a lucrative spell again any time soon.” They go on to say the advice being dispersed by the financial media was to stay out of the market until conditions stabilized. “This was, as usual, useless [advice]. If you wait for jitters to subside, it is always too late.”

It was interesting to read the Times piece in conjunction with another very good article on August 24 in The Wall Street Journal: “The Mistakes We Make—and Why We Make Them.” Author Meir Statman, a professor of finance at Santa Clara University in California, explores the question of “What was I thinking?” This pertains to people who sold stocks during the crash or who passed up opportunities to buy stocks at “once in a lifetime” values.

If you did get out of the markets and missed the rebound because you were calm seaswaiting for the seas to calm, you may well be asking yourself, “What was I thinking?” It’s all too easy to beat ourselves up because we didn’t see a market drop coming or we invested the wrong amounts in the wrong stocks at the wrong time.

Statman makes a strong point that “hindsight is not foresight.” It’s easy to see our investment “mistakes” when we look back. Yet predicting accurately what is going to happen in the markets is simply not possible. Therefore, it’s not realistic to think we “should have known better” and should have been able to make wiser choices.

This certainly doesn’t mean none of us are capable of wise investment decisions or that making money in the markets is simply a matter of luck and no more predictable than winning the lottery. But focusing on past mistakes doesn’t help us make better choices in the future. In fact, it can paralyze us and lead to making the biggest investment mistake of all—not investing.

Statman’s article, at online.wsj.com, should be required reading for every investor. He discusses the emotional aspects of investment decisions and talks about ways to avoid making investment mistakes in the future.

rough seasHis bottom-line recommendation is the same principle I have followed for my entire career: invest in a diversified portfolio in five or more asset classes and focus on the long term. Trying to time the markets is like setting out in a tiny canoe that will be swamped by the first big wave. Asset class diversification gives you a sturdy ship capable of handling rough seas and coming out safely on the other side.

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