Curbing emotions during turbulent times can be a challenge but is important for long term investors.
Volatility in the stock market can prompt some investors to make poor decisions.
EMOTIONS CAN BE A powerful impediment to investment success, particularly when tweets create stomach-churning market volatility.
Investors able to avoid fight or flight responses to market volatility are more likely to be successful.
The following five points can help investors navigate today’s turbulent investment environment:
- Take a breath.
- Understand that volatility doesn’t have to be a destructive force.
- Clues to the future can be found in the past.
- Time can be your friend or your enemy.
- If something sounds too good to be true, it probably is.
Take a Breath
Continuous business and political news, technology disruption and geopolitical turmoil create considerable investment challenges. In the words of Fidelity International CEO Anne Richards, “This time isn’t different but is faster.”
Markets react much more rapidly to news than was the case in the decades before widespread internet adoption. The influence of presidential tweets, as demonstrated most vividly in the U.S.-China tariff saga, is a more unsettling cause of market volatility.
Overreaction to news can be hazardous to investment returns. The most successful investors generally pause before giving in to fight or flight emotions, channeling their emotions into analysis before making investment decisions in response to the latest tweet or headline.
Volatility Doesn’t Have to Be Destructive
Volatility, by itself, isn’t necessarily harmful to investor portfolios. The permanent loss of capital associated with making bad investments or selling at inopportune times is far more damaging than short-term spikes in market volatility.
Investors with well-diversified portfolios who maintain enough liquidity to avoid being a forced seller are in a better position to weather the storm when market volatility picks up.
It also helps to have the emotional control to avoid panic-related selling. Successful investors such as Warren Buffett embrace the positive aspects of market volatility, with market dislocations providing periodic opportunities to invest in good companies at “discounted” prices.
Clues to the Future Can Be Found in the Past.
Populism, trade tensions and debt buildups are nothing new. Examining history can be helpful in assessing the likely consequences of different courses of action.
The imposition of steel tariffs in 2018 created predictable consequences for investors who studied prior trade actions. The good news, according to Commerce Secretary Wilbur Ross: U.S. steelmakers added about 1,000 jobs since the imposition of tariffs on imported steel.
The bad news was for steel consumers that paid a steep price for the incremental boost in steel employment. Ford Motor Co. (ticker: F), General Motors Co. (GM) Caterpillar (CAT) and Whirlpool Corp. (WHR) estimated that tariffs cost them more than $2 billion.
History is also relevant for investors considering the implications of policies gaining favor with progressive politicians.
Wealth taxes aren’t a new phenomenon, and an examination of recent experiences with a wealth tax in France may provide valuable insight. There is also considerable historical data about the implications of high marginal tax rates on economic growth and investment returns.
The Beatles song “Taxman” inspired by the high marginal tax rates of mid-1960s England is a cautionary reminder of a time in which the country was known as the “sick man of Europe” because of poor economic performance.
Time Can Be Your Friend or Enemy
Professional investors learn that time is a precious commodity.
Too many investors fail to take the time necessary to thoroughly review financial statements, research publications and other sources of investment insight. Inexperienced investors often underestimate the time commitment associated with investing in stocks.
Making snap judgments is one of the most frequent mistakes made by investors, and one of the easiest to avoid. Time is often a cure for volatility as well. Investors with a long term time horizon are less vulnerable to short term volatility.
If Something Sounds too Good to Be True, It Probably Is
This maxim holds particularly true when it comes to political promises.
Medicare for all and the Green New Deal sound good but may carry a steep price. Examining the likelihood of implementation is a necessary analytical dimension, as is understanding the implications for federal debt, interest rates and industries.
Consumers should also do their homework on “free” offers from investment firms. Most investment firms are for-profit entities, so it’s important to understand whether there is implicit compensation that comes from cash balances, funds offered by the sponsoring firm, or cross-selling of products.
An informed buyer understands the implicit trade offs and can make an informed decision about whether those trade offs are desirable.
Monitoring the portfolio is an important but oft-neglected aspect of the investment process. Patience is a necessary characteristic for successful investors, but there is a fine line to be drawn between patience and complacency.
The stock market is an adaptive system that constantly changes in response to new information. Many investors successfully identify winning stocks but fail to have the sell discipline necessary to identify when a winner has run its course.
One of the biggest challenges in investing is distinguishing between market moving news that changes the outlook and noise that doesn’t change the outlook. Doing the work necessary to distinguish news from noise is hard work, but worth the effort.
This article first appeared in usnews.com website. Reproduced here for our readers.