Markets are looking pretty ugly this morning, with Europe coming off a nasty 5% down day.
Whenever we see this happen, humans engage in a panicky reactive approach regarding their investable assets.
As I have suggested all too many times, you should have a proactive approach that recognizes the reality of these all too regular hiccups, and plans accordingly. You also need discipline to follow your plan, and the ability to handle your own emotional turmoil.
Both are much easier said than done.
For the typical investor, I have long suggested the following Investment philosophy: If you are an individual managing your own portfolio, as a general rule, I favor dollar cost indexing on a monthly basis. For most people of reasonable means, this is the lowest risk, highest return approach. No stock selection, no market timing, nothing exotic. I also advocate layering a risk management approach on top of that, even if its something as simple as using a 10 month moving average as a sell signal.
In my day job, we like to explore ways to do better than market averages. This involves both costs and risks.
But the above pretty much sums up your three options. To grossly oversimplify, in equity markets you can have as your goal:
1. Market Performance
2. Market Performance with less Risk
3. Market Out-Performance
There is also the widely enacted but little discussed failure to achieve the above, a little something called Market Under-Performance. Far too many over-active traders engage in some version of that. Even the better traders tend to forget about friction — costs, commissions, fees, taxes — that makes beating markets so challenging.
As I am fond of saying, the time to grab that card from the seatback in front of you, look where the emergency exits are, where oxygen masks are located, and whether your seat is a flotation device is when you are on the ground and the stewardess is giving her spiel. At 30,000 feet with the engines on fire and the wings coming off, it is likely to late to think about emergency exits.
Which brings us to today’s session. Regardless of the woes in Europe, a probable US recession, a possible QE3, the 2012 Presidential election, the next Quarters profits, amidst the endless idiotic blather coming out of your TV, you should be doing nothing more than executing your well thought and intelligent plan. (You do have a plan, don’t you?)
As previously noted last month, I am sitting in 50% bonds and cash, the rest in high quality dividend paying equities with a cherry of gold on top. I can comfortably wait for stocks to get cheap enough to buy, whether that turns out to be at SPX 1050 or 750. I am not looking to bottom tick the market; rather, we want to buy good asset classes at reasonable valuations. This means that over the long term, clients get good returns in light of whatever risk they assume.
None of this is rocket science. Rather, it is about understanding the regular market dislocations, the full economic cycle and human psychology. This also means understanding your own predilection to occasionally overreact.
Panic tends to lead investors to make bad decisions at the worst time. But it also means you are doing something wrong. Figure out what that error is – and then fix it.
This post originally appeared at The Big Picture and is reproduced here with permission.