Maybe investors should be “nattering nabobs of negativism.” This expression, coined by Spiro Agnew (honorary captain of most crooked ex-Vice Presidents) has some validity. In other words: Embrace the suck!
In the age where everyone gets a trophy, and self-esteem is falsely built up (without accomplishment to back it up), maybe investors should go against the grain and embrace the horror.
The right kind of pessimism can beat “pie in the sky” optimism any day, regarding investing.
In his engaging book, Originals, Adam Grant discusses Lewis Pugh, the best cold-water swimmer on the planet.
Pugh can do something you and I cannot. Before swimming, he can raise his body temperature from 98.6 to 101 degrees Fahrenheit. This seemingly supernatural ability is called “anticipatory thermogenesis.”
Pugh swims North Pole waters that can reach as low as 29 degrees! For some perspective, Titanic passengers died in water that was 41 degrees.
Pugh practices something called defensive pessimism. In his dangerous field it is imperative that he imagines any possible scenario that could go wrong and create an anticipatory plan for it.
This strategy can work well in specific situations to manage anxiety and fear. This prevents individuals from allowing themselves to be crippled by terror.
Grant states, it allows people to “deliberately imagine a disaster scenario to intensify their desire to convert it to motivation.”
Forcing people to consider the worst motivates them to find ways to avoid it. It often gives them a sense of control over unpredictable scenarios.
This will enable them to succeed when the actual event arrives. This is because their anxiety has already peaked ahead of it.
They will have built confidence to endure the harshest of their imagined nightmare scenarios.
According to Grant, they get their “confidence not from ignorance or delusions about the difficulties ahead, but from realistic appraisals and exhaustive planning.”
Their negative thinking negates the possibility of complacency. This is vital to tasks dealing in matters of life and death. Military planning would be a prime example.
How can defensive pessimism aid investors?
Though the markets are unpredictable, and success is based on probability (and not certainty); this strategy can work, using the right tools.
Let’s say you are a person who is absolutely terrified of a 2008-like re-occurrence of a global market meltdown.
How does one prepare for 50% plus market losses and the psychological trauma that accompanies these financial perfect storms?
It turns out that taking a page out of Mr. Pugh’s ice water swimming manual is a pretty good idea.
Preparing for the worst ahead of time and having peak anxiety before (rather than during) the market crash will save you a lot of money and minimize your mental duress.
So, for example, instead of losing limbs to frostbite, your main concern is avoiding a steady diet of Alpo during your golden years.
Here is what you can do to harness your negative energy and pessimism into a productive plan that relieves anxiety and increases the probability of a successful outcome:
- Make sure you own high-quality treasury or corporate bonds for the defensive component of your portfolio. Make sure “bond substitutes,” like MLPs and Emerging Market Debt, are properly characterized as stocks.
- Create a savings account that contains funds you might think you will need in the next five years. This money should only be invested in FDIC-insured savings accounts and C.D.s.
- Keep a portion of your portfolio in a flexible/tactical rules based model to help protect against 50%+ stock market declines.
- Speak with your accountant about the potential for tax-loss harvesting during a financial free-fall. Have a plan in place to lower your current tax bill and benefit from a future recovery.
- Keep your investment expenses low. There is nothing worse than paying high fees on products that are experiencing double-digit losses.
- Diversify broadly, and with extreme prejudice.
- Have a will, healthcare proxy, and power of attorney in place, along with disability and life insurance policies. Checking these items off your list is a terrific way to burn your anxiety-fueled energy.
- Turn off the T.V. during the crisis period. This will not be your life raft. Pouring kerosene on a raging fire rarely ends well.
No one could ever accuse you of being a Pollyanna if you implement this plan.
Others may snicker at your caution while they ride the bull with triple leveraged funds; let them.
You will have accomplished three things that will let you ride out the storm and live to fight another day:
- Established a sense of control over the uncontrollable;
- Created a realistic appraisal of a worst-case scenario; and
- Constructed an exhaustive plan to deal with your anxiety, and alleviate your worst fears.
Tony Robbins’ power of positive thinking may not be a sufficient antidote in the face of an inevitable market crash. Plus the hot coal walk can have some unwanted side effects.
Steer your pessimism into constructive action; that will let you sleep at night.
Everyone has the option to channel their energies into productive or destructive behavior.
What is your choice?