By Jack Forehand, CFA, CFP® (@practicalquant) —
2022 has certainly been a challenging year for markets. Although the S&P 500 is only down about 15% for the year, which is significantly less than we have seen in major bear markets, the path to get there has been a volatile one filled with both significant declines and major bear market rallies. These types of markets can be some of the most challenging for investors, as the swings from optimism to pessimism can come quickly and can challenge our emotions.
Although many of us like to focus on what we own and the details of our investment strategies, in times like these, behavior can play a far more important role in whether we achieve the outcome we are looking for. The ability to stay the course and adhere to our long-term plan is the most important when the consequences of not doing so are the most severe. And now is certainly one of those times.
But doing that can be easier said than done. Over time, I have found several things can be helpful in helping to achieve that goal. There is no magic bullet when it comes to behavior, and what works for one person won’t work for another, but here are some approaches I have seen that can help.
1. Have a Plan
This one is almost too obvious to list, but I am always surprised by how many investors don’t have one. Understanding what you are trying to achieve and what you need to do to get there is crucial to staying the course when things get tough. During periods like this, knowing where you stand relative to your long-term goals can be a huge help. For example, even though the market is down 15% this year, knowing that you are still on track to meet your objectives can help to put everything in the proper context and prevent behavioral errors.
2. Know the Facts
Declines like this are part of investing. They happen fairly frequently and are the price we have to pay to get the long-term returns the stock market offers. So to anyone who has studied market history, they are not a surprise. But that doesn’t make them feel any less painful when they happen. A good way to deal with that pain is to remind yourself that both corrections and bear markets are par for the course. When we are living through them, it always feels like they will never end and things will only get worse. But eventually they always improve.
One of the things we did with clients that we found helpful was to create a document up front that outlined the worst stock market declines in history and the worst underperforming periods for the factor strategies we follow. Doing this doesn’t eliminate the pain of these types of periods, but it does help to set expectations and can be useful as a guide when markets are down.
3. Look Less Often
One of the behavioral problems I suffer from is my inability to avoid checking my accounts. When you take a step back and think about it, checking your accounts regularly doesn’t really serve much of a purpose. But it can still be tough to resist. If you are following a sensible long-term strategy, these regular checks don’t offer any real value. But they do make declines more stressful and increase the odds of a major mistake.
4. Have a Small Side Account
This one only applies to more active investors, but it can be useful in substantially reducing the impact of the mistakes of more active trading. Some investors just can’t help themselves when it comes to trading inside their accounts. They just have to make changes even if they know the impact of their trading isn’t likely to be a positive one. One good way I have seen to deal with this is to take a very small portion of an investor’s portfolio and designate it as a trading account. This allows them to get their need to trade and make changes to their portfolio out of their system, while also minimizing the impact of that trading on the overall portfolio. For investors who just can’t shake their need to be active, this can work really well.
5. Remember What You Are Saving For
Sometimes a picture is worth a thousand words. Difficult market environments can be one of those times. When markets decline, focusing on the tangible reason we invest in them in the first place can be very helpful. For example, if I am looking forward to retiring to Florida and having a nice house on a lake, having a picture of that house in my mind can help me filter out the noise and focus on what I am trying to accomplish. Or if I am about to move my child’s college account into cash during a decline, looking at a picture of them and thinking about the importance of their education can help prevent a mistake. Attaching investment outcomes to tangible things that are important in our lives can be a useful tool in keeping in mind what is really important.
Fighting Our Own Worst Enemy
There is no one tool to help deal with bear markets and volatility. And what works for one person may not work for another. But the one thing we all have in common as investors is that we are often our own worst enemy. That is especially true during times like these. While no approach is foolproof, I have found that these ideas can help investors stay the course during the times when it is most important to do so.
Jack Forehand is Co-Founder and President at Validea Capital. He is also a partner at Validea.com and co-authored “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”. Jack holds the Chartered Financial Analyst designation from the CFA Institute. Follow him on Twitter at @practicalquant.