Don’t be emotional

“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” At a recent international investment conference an investment advisor related the following story. He has been flying kites as a sport for years. While not an expert, he has learned a few tricks by observing the flying behaviour of these kites. He told me that one of the most difficult skills for beginners to master is what to do when their kite starts to plunge earthward. The natural, panicky impulse is to yank backward on the lines. However, this action only accelerates the kite’s death spiral. The simple kite-saving technique is to calmly step forward and thrust your arms out. This causes the kite’s downward acceleration to stop, allowing you to regain control of the kite and end its plunge. What does this have to do with investing?

On January 21, 2008, the global equity markets all collapsed. For some markets it was the worst day since the Great Depression. And the Australian market had its worst day ever! This type of market move generally leads to panicked selling. And the media fuels the frenzy.

As I have learned to expect, I received two phone calls from the media to discuss what investors should be doing in light of the bear market spreading around the globe. What I find amusing is that I always give them the same answer – investors should do nothing except adhere to their well-thought-out investment plan, assuming they are knowledgeable enough to have one.

While it is tempting to believe that there are those who can predict bear markets and, therefore, sell before they arrive, there is no evidence of the persistent ability to do so. On the other hand, there is a large body of evidence suggesting that trying to time markets is highly likely to lead to poor results. For example, one study on 100 pension funds that engaged in market timing (allowing the purveyors of such strategies to charge high fees) found that not one single pension fund benefited from their market timing efforts. That is an amazing result as randomly we should have expected at least some to benefit.

Summary
Returning to my friend’s story about flying kites. Just as when the kite starts to plunge earthward the natural, panicky reaction is to yank backward on the lines, the natural, panicky reaction to a dive in your investment portfolio’s value is to pull back (sell). In both cases, pulling back is the wrong strategy. The right strategy is the less intuitive one of remaining calm and stepping forward, actually buying stocks to rebalance your portfolio to the desired asset allocation.