While markets tumble and pundits howl with fear, there is a proven solution to this madness. Create a globally-diversified, low-cost portfolio that will benefit from the completely normal temporary stress that markets routinely endure.
I find it amazing that people continue to have the same reaction whenever markets go south. The tired photos of traders holding their heads in despair on newspaper front covers are recycled.
The usual suspects, with their previously discredited advice, are broadcast on financial T.V., screaming about buying gold and the Dow falling to 1,000. Twitter becomes an insane asylum where all the lunatics have escaped and people are trading their portfolios based on the ravings of madmen.
Call it Groundhog’s Day. Bill Murray is reliving the same day over and over. Think of Charlie Brown continuously listening to Lucy’s siren song and repeatedly falling on his ass whenever Lucy pulls the football away as he attempts to kick it.
This is what happens, over and over, when perfectly normal market downturns occur and people rush to liquidate their accounts. They never learn! It doesn’t matter that since 1928 stocks have been in at least a 10% draw down 55 percent of the time. This small fact be damned!
The notion that markets correct between 8-20%, on average, pretty much every year and 20% or more every four to five years is thrown by the wayside.
“This is the ‘Big One’ and I am getting out before I lose everything.” This mantra is reinforced by the likes of CNBC who puts up graphics of “Markets in Turmoil” on days when stocks are not even trading!
It is also used by hucksters looking to sell products to “protect” you from losing all of your money. They fail to mention that the market goes up about two out of every three years, on average; betting against human progress is a loser’s game. Following the advice of understanding that a disproportionate of success comes from knowing what to avoid would be very welcome here.
Nassim Taleb wrote a book called Antifragile: Things That Gain from Disorder. Though I freely admit I do not understand most of what he says, and his complicated equations are way beyond my pay grade, this book was much easier to grasp.
He states, “Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk, and uncertainty. Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.”
One could apply this to having a globally-diversified portfolio and re-balancing it on a regular basis. This means you are consistently buying low and selling high in order to keep your original percent allocations of stocks, bonds, and cash in place.
Let’s use an example of an investor who has a standard 60% stock and 40% bond portfolio. While others are rushing to buy gold or triple-leveraged bear funds when markets temporarily explode into chaos, this investor sticks to his plan and rebalances.
This means he sells some of his highly appreciated assets, like Treasury bonds, and uses the proceeds to purchase stock that has fallen to very attractive levels.
Since the broad market indices have never failed to reclaim previous highs over extended periods of time, this portfolio would become antifragile. Market stress would result in more attractively prices (i.e., assets with lower present valuations with the potential for higher future returns).
The results will not show up over weeks or months. Decades will determine the true strength of the portfolio and the results of this proven strategy.
Think of building muscle, one cannot strengthen them without stress. People have realized this by implementing more challenging exercise regimens, like Cross-Fit. Hormesis works by adding a small amount of poison to a system to make it immune to the more lethal effects of a large dose.
A portfolio can also be strengthened by stress, provided it is properly constructed.
This means having a financial adviser who only adopts an evidence-based, long-term strategy (and who refuses to indulge clients’ emotional swings). Once decided upon, this strategy is adhered to through both the thick and thin of market cycles.
There are no sales incentives or magic pills that provide a cure-all for the inevitable periodic market declines. Unfortunately, very few investors have this type of stewardship.
This perfectly explains the illogical reactions of most market participants to perfectly logical market corrections.
In other words, don’t fear the reaper. The old saying, “Whatever doesn’t kill you will make you stronger,” applies to an appropriately constructed evidence-based portfolio.
In the words of Thomas Rowe Price, “Today is the most difficult day to invest.” While times might be temporarily tough, your periodically re-balanced global portfolio should strengthen over the years from temporary market dislocations.
If this time-tested strategy does not work over the next decades, we will have much bigger problems to be concerned with than our 401k balances!
We will all most likely be farming our small plots and using the barter system. Embrace the horror and set up your portfolio for future rewards.
Unfortunately, there is no other way.
