Whenever there is market volatility -- especially downward volatility -- certain kinds of articles spring up on Seeking Alpha and other sites like crabgrass in the summer. You know the kinds I mean. They have titles like "Buy And Hold Fails Again," or "What To Do About The Coming Crash," or "Market Downturn Is Inevitable; Time To Go To Cash?"
The common theme is fear. Fear of losing money as prices slide downward for who knows how long. Fear of giving up in just a few weeks or days the gains that it took several years to achieve. Fear of falling behind a benchmark and never catching up. Fear of underperforming your neighbor.
My own personal antidote to fear of the market is to focus on the income from my investments rather than their capital value. The market controls their capital value, but it does not control their income. So market volatility has little meaning for me.
When I want to buy something, I look for good values, so however the market is pricing a stock that I want to buy on that particular day becomes important. But it is only important with respect to the valuation of that stock on that day -- not in some cosmic sense of the market is falling or we're in a correction, or we're all in trouble. In writing about my approach and reading what others write, I have come to realize that my approach does not work for everyone. I have seen enough articles and comments written by and about income investors that display fear of the market that I understand just saying "focus on the income" is not enough to allay market fear for many investors.
So I did a little research into the subject of overcoming fear itself in many contexts, including investing, to come up with a collection of techniques or ways of thinking that might resonate with more people than my own "focus on the income" mantra. My hope is that one or more of these may help some readers to overcome their fear of declining markets and falling asset values.
1. Remember Buffett
One of Warren Buffett's most famous quotes is this:
I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy.
This sounds like a simple homily, but it is actually quite profound. It's really about valuation of stocks rather than their prices. The quote can be broken down into its layers of meaning. The first layer is that many investors -- the "others" in the quote -- become fearful when prices are going down. That's pretty obvious. The second layer is that when prices go down, valuations get better, all else being equal. That is far less obvious. What Buffett is saying is that the time to buy is when prices are low, even though that may coincide with rampant fear in the marketplace.
Buffett has repeated this theme hundreds of times in different ways. Here is another quote that amounts to the same thing:
The most common cause of low prices is pessimism-some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces.
In a similar vein, Buffett has repeatedly described how lower prices (meaning better valuations) benefit the investor over the long term:
If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. .. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
2. Remember Buffett Again
The quotes above refer primarily to when to buy. What if you have already bought, you already have a nice portfolio? Fear then prods you to sell. Many studies show that selling at inopportune times is part of what causes many investors to underperform. Buffett has an answer for that, too:
[W]hen we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.
This one is similar:
Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.
3. Increase Your Familiarity
This is a common technique for overcoming fear. In investing, increasing familiarity would mean doing research and monitoring your portfolio. But the monitoring is not about whether it is up or down on a given day. The monitoring is into the companies that you own: Are they still good companies? Do they still have the qualities you liked when you bought them? Does the fact that their prices are falling really mean anything, or is it just random noise with respect to their quality and earnings power? Is their earnings power still strong?
Your research can extend to the market itself, not just your stocks. If you think long term, you know that the market goes up long term.
Click to enlarge image.
Source: Doug Short.
If you've had a portfolio that has been working well for you for several years, with you managing it, should a market correction cause you to change strategies? Give serious consideration to that question. Don't ignore it, but turn to face it and look directly at it. The answer will vary for different people.
The best answer, of course, is that you anticipated market corrections, and that you already know how you will react when they occur. Your reaction will not be the product of panic. It will be the product of having thought about the situation before it occurs.
By failing to prepare, you are preparing to fail. -- Benjamin Franklin and/or John Wooden
Of course, your research may lead you to discover that one or two of your companies are actually having fundamental troubles. Perhaps they no longer fit the profile of companies that you want to own. In that case, seriously consider selling them. Such a sale would not be the product of fear. It rather would be the businesslike outcome of a businesslike decision. There really is not much emotion involved.
4. Reframe the Fear
Perhaps you see a market correction (or rising interest rates, or the withdrawal of QE) as a crisis situation. Instead of panicking, try to see it from another perspective. Consider the larger context. Create a comparison in your mind that makes your fear seem trivial, irrelevant, or manageable.
That is essentially what I do when I focus on the income from my investments rather than their prices. I have reframed the entire objective of investing itself. We are all brought up to think that investing is about becoming rich, beating the market, or getting to "The Number" that we need for a happy retirement. These thoughts are reinforced constantly by frantic media coverage of every market move, Wall Street advertisements, and increasingly nowadays by social media.
There is little from those sources that will help you reframe the fear of a declining market. In fact, most of them add to the fear. Fear sells, and writers, editors, programmers, investment pundits, and advertisers know that. So you have to do the reframing yourself. My reframing goes like this: What I really need in retirement is income. I need income to meet expenses, income that replaces the income I made when I was working, and income that grows faster than my expenses. It doesn't matter if I become rich in the traditional sense, provided that I have the income I need to have a happy retirement.
The market, for the most part, has nothing to do with my income. The market does not change my pension or my Social Security. It does not change the dividends that my companies send me. I own companies that have raised their dividends for years, through every bear market and correction that has occurred (in some cases) since the Kennedy administration. Why should I fear the current market slide? Corrections and bear markets have happened before, and they will happen again. There is no reason to fear them. They represent normal market behavior.
That's my reframing. It may not work for you. If not, create your own framework for thinking about market declines in a non-fearful way.
5. Confront and Analyze Your Fear
Perhaps this should be No. 1. Confronting fear is one of the most recommended ways of dealing with it. You begin by acknowledging it and taking ownership of it. Give it a name. Write it down. I am a great believer in writing things down. It helps me understand perplexing things better when I force myself to articulate them in complete sentences and put them in a logical order. In investing, I am a great believer in having a plan. I call my investing plan my Constitution, and I have written about it many times. (Here is the constitution for my Dividend Growth Portfolio.)
My goal is stated clearly up front:
The goal of the Dividend Growth Portfolio is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. The numerical target is for the portfolio to
deliver 10% yield on cost within 10 years of inception. I am more interested in the ability of this portfolio to produce income than its sheer size.
The fear created by a declining market clearly is the fear of losing money. Let's give it a name: Sucker. OK, now we have defined our fear and named it. What are some things we can tell ourselves that might help us overcome that fear?
- The market was overvalued, and now it is correcting. That was to be expected, there is nothing to fear in the process. This is just normal market noise. I won't try to time my way in and out of a volatile market, I will simply stay the course. Over long periods, the market returns again and again to fair value.
- Or, I will try to time my way around the market. In doing so, though, I will not be influenced by fear. I will develop a logical, articulable method of timing my buys and sells. I will consider every decision as an experiment, and I will learn as much as I can from every one, so that over time I become better at it. I will create a document that describes exactly what I am doing and why, and I will update the document every time that I learn something so that I am better next time, and so that fewer and fewer things take me by surprise.
- If I don't sell anything, I haven't really lost anything. If I am not in an immediate need to realize cash by selling, it doesn't matter much if market prices slide for a while. I know that over the long term, I can eliminate the need to sell anything by creating a cash reserve to get me through short-term periods of declining market prices. I'll convert the energy going into my immediate worry over market prices into something more productive by thinking about whether my reserve should be for six months, a year, two years (or more) of predictable expenses. Then I will think about how best to put together that reserve.
- I live off my income. I don't need to sell anything right now. Therefore, the declining prices of what I own are not very meaningful. They don't affect my investment income a bit.
6. Think Positive
One of my favorite investment authors is Dr. Bob Rotella. Never heard of him? Maybe that's because he is a sports psychologist, not an investment pundit. Rotella specializes in working with golfers. He knows, as do most elite athletes, that a positive attitude and self-confidence are almost always hallmarks of great performers. Among Rotella's 10 commandments for golfers are these that transfer easily into the world of investing:
- Love the challenge of the day, whatever it may be.
- Get out of results and get into the process.
- Playing with a feeling that the outcome doesn't matter is almost always preferable to caring too much.
- Be decisive, committed, and clear.
- Be your own best friend.
The translation of these kinds of thoughts to the investing world are pretty straightforward. If I had to summarize in a paragraph, Rotella's investing advice would be this: Don't fear the market, embrace it. Create a methodical investing process that works for you, then work continually on making it better. Don't invest with perfection in mind, because that is an unattainable standard. Don't regret mistakes for very long; instead, learn what you can from them and then move on. The only investment decision you can do anything about is the next one, so focus on that. Take time once in a while to appreciate your accomplishments, instead of dwelling all the time on your mistakes. Stop watching the market or your portfolio obsessively.
I apologize for all of the pop psychology in this article. I am not a real psychologist, and I don't play one on TV. But I think I have a fairly good handle on investing psychology for income investors. (I would not say the same about traders' psychology.)
If you notice, there are a couple of overarching themes that run through all of the suggestions. One is patience. Seeing things from a longer perspective usually helps. This may be especially hard for very young (restless) or very old (retired) investors: Both groups may believe or feel that they must see results now. My suggestion would be to try to reframe that feeling, break it down into pieces, and see whether it really makes sense. Perhaps there is another point of view that would relieve the pressure and still be believable to you.
The other overarching theme is to step back and take a larger view. Try to put small phenomena into a larger context. Try to place short-term events into a longer timeline, thus creating a less fearful perspective.
One thing that I do is watch CNBC every so often and literally count the number of things that push you toward hyper-fast thinking: The constantly rotating market numbers. The loud voices and reports that are screamed rather than spoken. The promos for upcoming pundits distracting you from what the pundit onscreen right now is saying. The flashing light at the right end of the day's continuing market chart. The color red (alarm!) signifying anything down. The words "Breaking News" (in red, of course).
Everything is short-term and immediate. Think about how that practically prevents you from adopting anything approaching a long-term view. Turn it off. You may find that a lot of your fear goes off, too.