When stock price declines create investor anxiety, advisers and commentators often respond with data about previous stock market declines, the futility of trying to time the market, relative valuations, and historical volatility — then punctuate that statistical recitation with the advice to sit tight and remain calm.
Having given that advice more times than I like to admit, I have learned that there are at least a couple of problems with that approach. “Sit tight” and “remain calm” are two completely different acts and are sometimes incompatible with each other.
The recommendation not to change your investment strategy at a time of extreme market volatility is only wise if you are already pursuing an appropriate strategy. If you’re doing something stupid or inconsistent with your goals, assets and temperament, then it probably doesn’t make sense to stick with a stupid plan, regardless of market conditions.
Extracting oneself from a stupid investment program is seldom as simple as flipping a switch, but if you decide you’re on the wrong horse, figure out which is the correct horse and get on it.
The recitation of market statistics seldom calms a nervous or panicked investor. Reviewing the 60-month return of the S&P 500 in all 5-year periods following a drop of 20 percent or more may be logical, but when you bombard an emotional person with logic, the natural reaction is to move more deeply into an emotional state. That is, when you tell people that their feelings aren’t supported by facts, it simply makes them angry.
The key to dealing with investment-related anxiety is to preempt as much of it as possible with proper planning prior to market meltdowns. It is much easier to be open to logic when in a calm, contemplative state.
If an investor hasn’t effectively reconciled his assets, goals and fears, any drop in stock prices can create a panic.
When determining an amount of your assets to invest in various asset classes, there are two correct answers: an algebraic one and an emotional one. Ideally, the answers are the same.
The algebraic answer is usually pretty simple to determine. What do you have to do to get to where you financially want to be, when you want to be there?
The emotional answer, however, is subjective. How much volatility can you withstand in pursuit of the algebraic solution? Even though you might think you know the answer to that question, it sometimes requires experiencing actual market losses to really know the answer.
Contradicting conventional wisdom, I have regularly noted that neither the sudden acquisition nor loss of money changes people; it simply reveals them. People who think they are emotionally able to withstand the sometimes extreme fluctuations in stock prices might discover otherwise when faced with real market declines rather than hypothetical ones.
David Moon, founder and president of Moon Capital Management, may be reached at firstname.lastname@example.org.