History Repeats Itself

Some things never change.  What is the one thing we should have learned from the market crash in 2007-2009?  Hopefully, it's that staying the course pays off.  Those that can tolerate some pain will be handsomely rewarded for their patience.  The only people that really got hurt in 2008 were the ones that sold.  Following the crash, the markets recovered all their losses and then went on to make new highs.  So with that fresh in our minds, what were investors doing during this correction?  You guessed it (via Merrill Lynch):

fund flows

Not only were daily outflows their highest level since 2007, but a collective $29.5 billion were pulled from equity funds for the week.  This is the worst level since they began collecting this data (which goes back to 2002).  Not surprisingly,8/25 marked the height of outflows this week and the S&P 500 is now up over 6% from that day.  Successful investing goes against every instinct we were hardwired with from our ancestors.  Our fight or flight response kicks in when we see losses in our portfolio and our brain tells us we have to do something. The best investors are those that can bury these instincts and think about their portfolio in terms of decades, not days.  

Do Less

There is a funny scene in the movie Forgetting Sarah Marshall when the lead actor is trying to learn how to surf.  His instructor continues to tell him, "do less" to the point where he becomes exasperated and just lays on the board not knowing how to follow his instructions.

If we are honest with ourselves this is probably similar to how the average investor has felt over the past couple weeks.  Doing less seems idiotic at times.  Everything we watch on TV or read seems to make us think we should be making changes to our portfolio.  The market is crashing, don't just stand there, do something!  The reality is that over time the less we do the higher the probability we have for a successful outcome.  

Doing "something" usually involves trading.  This is either to try to time the market or move into a different type of asset class.  There are two problems with this.  First, you probably can't do it consistently.  Think about it this way, no matter what you are trying to do, there is going to be someone else on the other end of your trade.  The competitiveness and brilliance in the market is astonishing today so if you think you will be able to consistently beat other market participants, you may be a tad overconfident.  Second, when you trade more often you are creating taxes and fees which ultimately will erode your portfolio.

The only caveat to this is that it is normally a good idea to rebalance your holdings if the portfolio has significantly strayed from your desired allocation. As hard as it is, and as silly as we may feel, you should fight your instincts and "do less" with your portfolio.  Your long-term wealth will be better off.

Do You Really Believe In Diversification? You Should…

Diversification is the only free lunch when it comes to investing.  I think investors nod their heads when they hear this phrase but most don't truly believe it.  Do you?  If you agree with this, have you bought any individual stocks in the past?  If so, I ask you again, do you believe in diversification because your actions don't match your beliefs?

There are some fascinating numbers coming out about winners and losers in the market this year.  Take a look at this chart from the Irrelevant Investor blog:

percent from 52 week high

The Russell 3000 is comprised of approximately 98% of the publicly traded stocks in the US market.  While the average stock is down over 20% from its all-time high, the Russell 3000 is only down 2.9% from its all-time high.  How is this possible?  There is a small group of stocks that are keeping this market afloat.  This is not very different from history either.  According to the blog, since 1926:

  • The average return of all stocks is 9.9%
  • Excluding the top 10% of performers, the market return falls to 6.5%
  • Excluding the top 25% of performers, the market return is negative at -0.3%

This shows us how important diversification is.  Market returns are historically driven by a small number of high flying stocks.  Sure you could pick one of those stocks in advance and really have outsized returns, but the odds are against you.  It is much better to diversify.  Smooth out your returns and accept what the total market will give you by owning the entire market.




Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.