There are many different ways to succeed as an investor.
If there were only one approach that worked, everyone would do that.1
I know plenty of investors with completely different styles that have found success in the markets over the years.
But there are only a handful of ways investors fail in the markets:
- Allowing your emotions to get the best of you.
- Chasing fad investments.
- Not following an investment plan.
- Thinking you’re smarter than the markets.
- Being overconfident in your abilities as an investor.
I’m sure I missed a few but that covers most of the big ones.
Every investor makes mistakes from Warren Buffett to the Robinhood trader. The hope is that you get them out of the way when you’re young and don’t have a lot of money at stake.
Unfortunately, sometimes investors make mistakes when they are older and have more of their life savings on the line.
The biggest investment mistakes tend to happen when you make a bad decision at the worst possible time.
The Wall Street Journal profiled a number of individual investors this week to see how regular people manage their finances in retirement.
This part of the story was painful to read:
Mr. Jones’s retirement account took a hit in 2008 and never recovered. Spooked by the S&P 500’s 38.49% decline in 2008, he sold his stocks and invested in a stable value fund that earned about 1% a year, said the couple’s son-in-law, Jon Older, a doctor who has managed the portfolio since 2018. Dr. Older moved 35% of the balance into a low-cost stock index fund and the rest into an intermediate Treasury bond index fund.
Each month, they earn $2,500 in Social Security, plus Ms. Jones’s $1,877 pension, the current value of which is about $300,000.
Selling out of their stocks after a crash had already occurred completely changed their retirement plans.
The Jones’s weren’t alone in selling out during the Great Financial Crisis. I’ve heard from dozens and dozens of investors over the years who went to cash but were never able to get back in.2
In some ways, it’s understandable why so many investors capitulated.
We had an 18-month-long bear market that saw the stock market fall more than 50%. And people were still licking their wounds from the bursting of the dot-com bubble, another market crash that cut the stock market in half earlier that same decade.
It’s just hard to see how selling out after you’ve experienced large losses is ever going to be a winning strategy.
Market timing is always difficult but doing so in the midst of a market crash makes it exponentially harder from a psychological perspective.
Hitting the eject button after suffering big losses can provide some sense of relief but any short-term feelings of comfort end up doing more harm than good.
Just get me out. I’ll get back in when the dust settles.
You become addicted to sitting in cash because it feels like the downside volatility will never end. And when stocks have a rip-your-face-off rally as they tend to do coming off a market crash, you talk yourself out of re-investing because you assume those gains aren’t going to last.
By the time the dust settles, it’s too late.
One year out from the bottom in March 2009 the S&P 500 was up almost 70%.
Two years later the market had nearly doubled.
By 2015 the stock market had shot up more than 200% from the lows.
It’s bad enough you have to sit through massive drawdowns in the stock market on occasion. But if you take the beatings AND miss out on the subsequent gains you end up losing twice.
So what’s the solution for investors who want to avoid doing irreparable damage to their portfolio during a market crash scenario?
Create an asset allocation you would be comfortable holding in any market environment.
This is a preemptive move so it’s not going to help you all that much if you’re already sitting on a pile of losses. But if you sell after a market crash takes place you either don’t have what it takes to invest in stocks or you were taking too much risk in the first place.
The whole point of a well-balanced asset allocation portfolio is that it should be durable enough to handle bull markets, bear markets, sideways markets, inflation, deflation, booms, busts and everything in between.
Can asset allocation save you from losses? No, there is no reward in the long run if you’re not willing to accept some risk of loss in the short run.
But if you don’t have a good handle on your risk profile and time horizon you increase the odds of making an avoidable mistake at the worst possible time.
Michael and I talked about investing mistakes and much more on this week’s Animal Spirits video:
Subscribe to The Compound so you never miss an episode.
Further Reading:
How Much is Enough to Retire Comfortably?
Now here’s what I’ve been reading lately:
- The age of average (Alex Murrell)
- Financial nihilism (Anti-Mimetic)
- Getting outside your comfort zone (Abnormal Returns)
- Important and unimportant things (JL Collins)
- Money vs. happiness (Humble Dollar)
1And if everyone did that thing that worked it would likely stop working.
2The article said the couple spends around $50k a year, meaning Social Security covers 60% of their expenses. This is why cutting Social Security for a large portion of the population is a terrible idea.
