Given the volatility we’ve seen over the past several days, I want to talk about keeping your focus on the process of investing instead of what impact the daily and intraday gyrations of stock prices are having on your net worth. I realize that any time stocks incur a significant drop like they did late last week and early this week, an unrealized financial loss occurs. But focusing on what is happening to your wealth on a daily basis doesn’t help you stay on track to achieve your long-term financial goals. What does help is to focus on your investing process, including the actions you take to prevent personal behavioral tendencies from harming your portfolio.
To convey my point, I’m going to focus on weight loss and fitness. I realize that this may seem odd, particularly right now, but there is a significant amount of overlap between wellness (which encompasses weight loss and exercise) and investing. Achieving and maintaining good physical and financial health is dependent on a person’s behavior, including whether he or she has strategies to deal with emotions, setbacks and obstacles.
A large number of books have been written about investing and weight loss. An even larger number of people are constantly seeking the magic formula for reaching their targeted weight or desired wealth. Yet there is no secret to either. Weight loss is a matter of making smart choices about what and how much you eat and being physically active. Successful investing is a matter of selecting good investments and sticking to a well-thought-out strategy regardless of what the market is doing. However, simply telling someone to “eat better and exercise more” is often about as useful as telling someone to “buy broad-market, low-cost index funds and just ignore the market downturns.” Good advice, but advice that often does not result in the desired change in behavior. If you truly want to achieve your goals, you have to have a process to do so—and the discipline to stick to the process.
This guidance is not coming from one who lives in a proverbial glass house. I’ve had to personally change my behavior. I wouldn’t be part of the National Weight Control Registry (a study that tracks people who have lost and kept off significant amounts of weight) if I hadn’t put on excess pounds in the first place.
Losing the weight and keeping it off required a long-term change in how I managed my health. A big key was that I focused on altering my behavior as opposed to losing a certain number of pounds. I gradually looked for ways to eat better and eat less. I learned to avoid foods that I wasn’t able to eat in moderation. I got on the scale even when I was worried about what number it might display. I exercised more (as of last night, my heart rate monitor, which I wear during my cardio workouts, says that I’ve burned more than 200,000 cumulative calories).
The single biggest reason for my success was a focus on the process, not the results, and the discipline to keep going back to the process. Regardless of what life threw at me (work, minor sinus and respiratory infections, vacations and even injuries), I made sure that I always reverted back to the process.
Investing is no different. How you go about investing is more important than the specific securities or funds you invest in or what type of mood Mr. Market is in. Even if you buy an average-performing mutual fund with average expenses, you will end up with more wealth than the investor who picks the best funds and securities but fails to adhere a good long-term strategy. If you want to be successful, process is everything. Focus on what you should be doing and the results will follow.
Will there be bad luck? Yes, and there’s not much you can do about it. Financial emergencies pop up. Bear markets occur at the most inopportune times. Jobs are lost. Stocks unexpectedly plunge because of surprising bad news from a company. You cannot control any of it. But you can control how you react and your willingness to revert back to the process as soon as you are able to.
Which leads me to the recent sharp drop in stocks. Ask yourself: How did you react? Did you sell out of fear of losing more money? Did you feel like maybe you should have pared down your stock holdings in June or July? Are you currently worried and/or uncertain about what to do?
If you answered yes to any of these questions, it simply means that you are human. We’re emotional beings who are programmed to anguish over losses. It’s normal to be unnerved by a sudden increase in downside volatility. How you react—even if reacting means purposely not doing anything—matters more than whether or not you are nervous.
Weight loss experts talk about triggers. Triggers are scenarios that cause someone to eat. They can be emotional and they can be physical. For example, we don’t keep any Ben & Jerry’s in my house because I will eat it, likely standing in front of the freezer…door open, pint of Chocolate Chip Cookie Dough ice cream in one hand and spoon in the other. My wife has her own list of trigger foods as well. We purposely keep certain foods out of the house to avoid being triggered.
The markets can have their own triggers. If you find yourself tempted to do something in reaction to a change in the Dow Jones industrial average, headlines about rising interest rates or something else you see or hear about, write down what it is. Then devise a system to control how you react to the trigger. It can be a rule limiting yourself to only looking at market news once a week. It can be requiring yourself to physically call your broker to place a trade instead of doing so online, a hassle that may cause you to rethink your decision. It can be a commitment to walking for 20 minutes before making any investment decision. It can also be segmenting a small portion of your portfolio that you are allowed to trade in and out of. Part of the reason I rebalance my own portfolio periodically is to have an outlet for my emotions—it’s something positive I can do when financial market conditions toss my allocations out of whack and attempt to trigger my own feelings of loss aversion.
While there are general guidelines for wellness (eat more vegetables, exercise regularly, etc.) and for investing (keep a long-term focus, control costs, etc.), the actual process for succeeding at both is very personal. The more you can figure out what works best for you and prevents you from succumbing to your personal triggers, the healthier and wealthier you will be.
I want to leave you with one final suggestion: don’t worry about being perfect. When I go to Las Vegas for our Investor Conference this November, I fully intend on enjoying some of the city’s great restaurants. So long as you stick to your process most of the time and don’t do anything to significantly derail it (e.g., go on an eating binge or pull out of stocks in reaction to fear about a market drop), you will be fine.
- The Role of Luck and Skill in Investing – Even though luck plays a big role in investment outcomes, developing a good process can increase the positive impact that skill has on your returns.
- A Lifetime Investment Strategy – This guide, written by AAII founder and chairman Jim Cloonan, explains how to create a strategy for achieving your long-term goals. It can also be helpful in establishing your own personal process.
- How Do You Stick to a Long-Term Investment Strategy? – Share your tips on the AAII.com Discussion Boards.
Just a handful of S&P 500 member companies will report earnings next week: Dollar Tree (DLTR) and H&R Block (HRB) on Tuesday and Campbell Soup Co. (CPB), Joy Global (JOY) and Medtronic (MDT) on Thursday.
The first economic report of note will be the Chicago PMI, released on Monday. Tuesday will feature the August ISM manufacturing index, the August PMI manufacturing index and July construction spending. The ADP’s August Employment Report, the Federal Reserve’s periodic Beige Book, revised second-quarter productivity and costs and July factory orders will be released on Wednesday. Thursday will feature July international trade data. August jobs data—including the change in nonfarm payrolls and the unemployment rate—will be released on Friday.
Three Federal Reserve officials will make public appearances: Boston president Eric Rosengren on Tuesday, Minneapolis president Narayana Kocherlakota on Thursday and Richmond president Jeffrey Lacker on Friday.
- 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses
- The Sell Decision: What to Do After a Severe Market Meltdown
- The Danger of Getting Out of Stocks During Bear Markets
Both optimism and pessimism jumped in the latest AAII Sentiment Survey. Neutral sentiment, meanwhile, plunged to a nearly nine-month low.
Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 5.7 percentage points to 32.5%. Optimism was last higher on June 25, 2015 (35.6%). (Bullish sentiment was also at 32.5% on July 23, 2015.) Even with this week’s increase, bullish sentiment remains below its historical average of 39.0% for the 25th consecutive week, the longest such streak since a 29-week stretch in 1993.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, plunged 10.6 percentage points to 29.2%. The large drop puts neutral sentiment at its lowest level since January 1, 2015 (29.0%). It also ends a record streak of 33 consecutive weeks with readings above the historical average of 31.0%.
Bearish sentiment, expectations that stock prices will fall over the next six months, surged 4.9 percentage points to 38.3%. Pessimism was last higher on July 29, 2015 (40.7%). This week’s rise keeps bearish sentiment above its historical average of 30.0% for a fifth consecutive week.
The recent streak of above-average bearish sentiment is part of a broader shift we’ve seen this summer. Pessimism has been above its historical average during eight out of the past 12 weeks. During the entire 52-week period prior to June 2015, bearish sentiment was above its historical average of 30.0% just nine times. Furthermore, bearish sentiment has now exceeded bullish sentiment for five consecutive weeks. This is the longest such occurrence since a seven-week stretch between October 11 and November 22, 2012.
This week’s concurrent increases in optimism and pessimism are indicative of the mixed view that individual investors likely have of the surge in volatility that occurred over the survey period, which runs from 12:01 a.m. on Thursday to 11:59 p.m. on Wednesday. Some members had previously stated that they were looking for a drop in prices to bring valuations down and create a buying opportunity. Others may be concerned that the market is at risk of further downside.
This week’s special question, which was posted at the very beginning of the survey period, asked AAII members how second-quarter earnings have influenced their outlook for stock prices. Nearly 40% of respondents said that the quarterly results did not influence their outlook, with several citing their long-term investment strategy as the reason why. An additional 7% said that other factors are more influential, such as the concerns about global economic weakness. About 9% of respondents described themselves as being more cautious or pessimistic because of second-quarter earnings. Only 5% of respondents said that corporate earnings made them more optimistic. A few members directly mentioned the recent correction instead of answering this week’s special question, though the comments were varied.
Here is a sampling of the responses:
- “One quarter’s earnings never influence my outlook for the long term.”
- “The bigger concern is the global slowdown.”
- “Earnings were okay, but the outlooks given by companies were not very comforting.”
- “Earnings were good and I am still optimistic on the economy.”
- “Not at all. The current sell-off is the primary influence on my outlook.”
Bullish: 32.5%, up 5.7 points
Neutral: 29.2%, down 10.6 points
Bearish: 38.3%, up 4.9 points
Local Chapter Meetings
August 20, 2015 The S&P 500’s Tight Trading Range
August 13, 2015 Timing Matters When Analyzing Investment Returns
August 6, 2015 Using Debt to Find Attractive Small-Cap Stocks
July 30, 2015 Don’t Judge Diversification by Its Short-Term Performance