Do not sell when the markets decline. If your investment horizon is long term, you should just stay the course. The long term trajectory of the stock market is up, and you will be fine.
How many of you have heard this advice before? How many of you act on this? Are you still “staying the course”?
Go forward but adapt to the rising danger
The Markets do not Work on Absolutes
First of all, beware of any advice that says do this regardless of the economic condition or whatever else may be going around in the world.
If you treat your investments like a business owner treats his business, you should absolutely not bury your head in sand and hope everything will work out over time. A smart business owner takes stock of the current situation and the expected future conditions and adjusts his business strategy accordingly. His goal is typically to maximize his profit. Sometimes, his goal may be to minimize his loss, assuming it is worthwhile to stay in the business to see the day when good times will come back. If there are situations when staying in the business is not worthwhile, the business owner will try to exit the business at the maximum price he can fetch in the market.
Why does he do this? Why does he not simply stay in the business with no business strategy changes? After all, the GDP in the US keeps going up over the long term!
I will tell you why. This is the most important truth that no one tells you in the market. This is the truth that is completely lost on the index fund generation.
The market is a place to efficiently allocate capital. The market actively works to deallocate capital from uneconomic projects and reallocate it to projects that make economic sense.
This re-allocation is why the GDP continues to go up over the long term. What is true of the GDP is similarly true of the stock market. The stock market trends higher over time because bad investments are weeded out and good investments are rewarded by additional investment capital. This is further helped along by the fact that increasing global population and inflationary monetary policies ensure that the number of profitable projects and investments keep increasing over time.
This reallocation of capital is absolutely essential for the stock market (or any free market) to function effectively.
By saying, stay in your investments regardless of the economic situation, you are perverting the economics to support your business model of passivity. Worse, you are saying that the stock market will continue to trend up over time as there are other people doing the capital re-allocation – I am just in this for a free ride!
The Free Rides Eventually End
Unfortunately for the personal finance bloggers everywhere, if you are not an active participant in making the markets work efficiently, the markets do not owe you anything in return.
Additionally, the base condition of inflationary monetary policies, and increasing global population, are not always true. When these change, whether it is because of greying of America, or a pandemic, there will be demand erosion in the economy, and the GDP and the stock market will no longer follow the natural curve upwords, as long as these adverse conditions remain.
When this happens, what would you rather do? Do nothing and wait for these shifts to reverse? This might take generations.
Stay on Course – The Real Meaning
Staying on course is important. But realize that the course you are staying on is the course of investing for profit in a way that advances the cause of the economy at large. Which means you actively avoid the bubbles and look for hidden gems. You want to back the projects (or stocks) that have potential to grow in value, and you want to exit the projects (or stocks) that exhibit froth. Investing in the stock market blindly with no regard to the valuations was one of the cardinal sins no rational investor should have committed in the last 2 years.
But commit this cardinal sin many of you did.
Why?
Because you lost track of why you were investing.
Staying on course means the following:
- Look for opportunities and avoid bubbles
- Exit the markets that don’t make sense. Even if it means exiting the entire market, like we pretty much did last year
- Stop coveting your neighbor’s stocks. Momentum is a workable strategy, but if you are reading this article you are likely to be a value oriented investor. Stay true to your core beliefs.
- Reconsider your investments as things change. Absolutely sell bad stocks and buy good stocks. If there are no good stocks, just sell the bad stocks. Staying in only because some talking head on TV says is a great idea is pretty idiotic.
- Index funds are not a panacea.
Have a Thick Skin
Staying true to your investment philosophy is not bed of roses.
It is much easier to look at all the money your friends are making and do the same thing, no matter the merit or lack thereof. If the market crashes, and your portfolio gets crushed, take solace in the old standby excuse “no one saw this coming”.
For most investors, the market goes in the cycle of:
This time it is different -> No one saw this coming -> …
Most investors are reactive
Smart investors are disciplined. They know that high valuations will eventually be righted. They may not know the trigger that would do it. For example, I do not know anyone who foresaw a global pandemic coming a year ago. I certainly did not. But I and many other investors knew that the valuations are unsustainable and will come down one way or another. We prepared and lightened up on our equity holdings. We raised cash and stayed in cash until the time is right to use this cash.
Intelligent investors anticipate
Sure, there were people who made comments like
- The market is setting new records and you are staying out of it. There must be something wrong with you
- Millions of people can’t be wrong
- My friends are making bank and I am being left behind
- It is unethical for an investment service to ask members to not buy
- and my favorite, a good investor should be able to find stocks no matter what is happening in the economy
It is always a pleasure to know that majority disagrees with my views. That simply means I am more likely to be correct.
Generally my investment priority tends to be in the following order
- Manage risk and eliminate it as much as possible,
- Go for profits
My experience has shown time and time again that keeping risk down as number 1 priority tends to result in higher profitability, than if you focus on profits first.
Long Termism Vs Short Termism
Do you focus on maximizing your profits for the long term or do you try to go for broke on every investment?
If you put profit before risk management, you are short term oriented. The decisions you make will be sub optimal to your long term portfolio growth.
If you believe risk management is key to long term portfolio growth, you will adapt and adjust when valuations and market conditions change. You will stay the course for the long term by sticking to your investment philosophy, but your investment philosophy will NOT be predicated upon “buy and hold your head in the sand“.
I understand I am making a very fine point and many will disagree.
Good.