Date: Mar 31, 2010
Following investment rules doesn't necessarily mean you won't lose sometimes. However, using the rules as a general, meaningful guideline, even if you have to be flexible at times, is wise.
Have you felt let down by an economic crisis? You might if you thought you were following all the investment rules you'd been taught. You may feel disappointed, resentful, and even angry. You are in good company if you are thinking, "I followed the rules! I should have won!" After all, doing so should entitle you to a certain reward. Doesn't following the rules protect you from losses, or at least minimize them?
Unfortunately, life doesn't work that way, and neither does the economy. Following investment rules doesn't necessarily mean you won't lose sometimes. However, using the rules as a general, meaningful guideline, even if you have to be flexible at times, is wise.
To succeed as an investor, you need to move beyond the emotional frustration of "losing" by examining your process and changing your behavior. This requires a constructive, focused, and objective mindset.
First, you have to acknowledge that there are no guarantees. But there are parameters to consider, and they are based on years of experience. Think of it this way. Picture a child running across the road between two parked cars on an active street. He makes it safely to the other side. He thinks, "Why do they tell me at school not to run between two parked cars? I did it, and nothing happened." Just because nothing happened one time doesn't mean it's a reasonable risk. One lucky win has nothing to do with the probability of future success. In fact, the probability of a win decreases with each risk taken because the odds will eventually catch up to you.
Yet sometimes this is how investors think. Either they have no investment rules, or they break their own rules and take on too much risk. When that rule-breaking strategy works, they do it again and again, thinking they are guaranteed phenomenal returns. Then they're surprised when they get run over!
The same scenario can also work the opposite way. An investor follows a rule, and it doesn't work. The investor "loses" and begins to think that following the rules doesn't matter because the rules can't guarantee safety. Think of a person who lives a healthy lifestyle, exercising and eating properly. She eats no fried food and avoids saturated fat. Can you guarantee that she won't get heart disease or cancer? No, but that doesn't mean that following the rules isn't a good idea. Although it may seem that the rules got her nowhere, the reality is they probably gained her a great deal. Could it be that her healthy eating prevented cancer from developing at an earlier date? Might she be more likely to beat heart disease because she is in great physical condition? Could it be that her quality of life before and during an illness could be improved by her healthy habits? Just as breaking the rules doesn't always lead to disaster, following the rules doesn't always lead to safety. That doesn't mean that following the rules is a bad idea.
When an economy turns south, many investors—including the ones who followed the rules—experience losses. This doesn't mean they should conclude they had poorly designed rules or that the rules don't work. Investment rules yield their effect over time. It's true that over short periods of time you might feel that you lost. You lost this one. You lost that one. But in the grand scheme of things, if you follow the rules—and we'll talk later about what those rule are—you're more likely to be on the right path.
Although you can't guarantee you'll never lose, what you can do is improve the probability of winning. That is what superior athletes do. Like the professional baseball player, all any of us can do is swing at the balls being pitched to us. And, like the baseball player, when you follow the right rules, you can increase your chances of getting a hit. You may not connect with the ball every time, but if you position your stance, practice your swing, and study the craft, the probability is that you are going to hit consistently over long periods of time. What do top players do to be in their best form? They study films, including those of the competition. They practice the skills they need until they are at the level of unconscious awareness. What looks like autopilot to us, the spectators, is really the result of years of active dedication to the sport. Top athletes are lifetime students of their game, and they learn to perform under pressure that includes less than desirable conditions. Will continual "perfect" practice always lead to a win? Is there a way to guarantee a connection with the ball? No. But practice greatly increases the chances of success. This reasoning applies to sports, investing, and anything else you value in your life.
Rules are guideposts that improve your probability, and that can make all the difference. What's the range, statistically speaking, between the minor leagues and the major leagues? For the best players, it can be very small. And yet, a ball player's life and the life of his family can be dramatically changed when he moves up to the major leagues and becomes a fixture there.
The same logic applies to the difference between mediocre and remarkable investment returns. From 1989 to early 2009, the Standard & Poor 500 stock market index return has been about 8.4% (J.P. Morgan Asset Management, Guide to the Markets, March 31, 2009). Can you guess what the average investor's rate of return has been over that period of time? About 2%. Why? Because investors, for whatever reasons, tend to buy high and sell low instead of doing the desired opposite. In any one year, the differential may not be that large. When you add all 20 years together, the cumulative effect is substantial.
Following are several ways you can improve the probability of "winning," which means increasing the potential for your investment performance.
Evaluate the Investment Rules You Followed
When you look back at the performance of your investments, ask yourself what rules you followed and how well they worked. Did you have the right rules? Were you following the rules that were appropriate for someone in your financial situation and at your stage of life? Did your situation change, and did that require revision to the rules?
This is how Rebecca describes her experience.
- Rebecca: My husband and I were on a wonderful trip, hiking in Switzerland, when he suddenly had a heart attack and instantly died. I can't even describe the shock and pain of this; I was numb for weeks. When I got home, among all my new obligations I had the responsibility of all our investments, and I had never done any of this before. I discovered that there was quite a bit of money in higher risk securities. I learned to use a computer and I took a course on investing. I wanted to handle things personally, and before I knew it, I was day trading! I guess because my husband was an active trader, I thought that's what I was supposed to be doing. I was in over my head. I felt like there were no rules, or the rules that my husband had relied on previously were no longer appropriate for me, an inexperienced widow. I realized I needed an investment strategy with boundaries and an advocate to stand by me. It was a great relief when I found an advisor who was supportive and sensitive to my needs.
Examine How Well You Followed the Rules
It's painful to lose money. It especially hurts if you felt you were following the rules. But for the higher purpose of helping you to empower yourself, you need to look at yourself honestly. Did you really follow the rules? Did you follow them as closely as you could? Did you have a realistic time frame, or did you lose patience with the process? Maybe you had rules you weren't following at all. Maybe you were following other rules because you got distracted from the original rules you established.
Charles talks about how this happened to him.
- Charles: For 20 years I have had a successful business in home security systems. I am confident and have a strong head for financial decisions. I always believed in diversification and therefore used different asset classes. This meant being invested in stocks, bonds, real estate, even art and collectibles. Each time I had a positive investment result, I added more money to that specific category because I was so pleased with how things were working out. Eventually, I had large sums deployed in more aggressive and illiquid assets, and the returns took a negative shift. I kept telling myself that these things just needed more time, but I ultimately had to acknowledge that I lost track of my own rules for managing risk. I was attracted to the high potential returns and forgot to limit the percentage of funds in each asset class.
Get Back in the Game
To paraphrase Yogi Berra, the game isn't over until it's over. You may have temporarily lost money, maybe even a lot of it. But as long as you're an investor committed to your future, you still have the opportunity to participate constructively as the market recovers. You have options.
You can improve how you're handling your investments. One of the ways you surmount a crisis is to remember that you can be a strong force in your financial recovery if you can step away for a minute to examine your game. What investments should you be in now? Are you in them? Addressing your investment strategy is one way to correct the mistakes of the past and position yourself better for the future.
You can cut your expenses. When you go through a financial crisis, suddenly you become an expert on what you must have versus what you can live without. Can you do some of the things you used to pay others to do and do those things just as well? Can you cut expenses without significantly reducing your quality of life?
You can add to your income. You may go back to work or earn some extra money by doing something for which you have unique expertise. You can sell things of value, like furniture or jewelry. You may love to have nice things, but can you live without them? Do you have any valuable objects you thought meant something to you and now you realize their intrinsic value has decreased? Perhaps now you can trade for cash and buy some time while you get stabilized.
You can prioritize your life. Maybe you lost some money in the financial markets, but did you lose in every game you were playing? Maybe you are focusing on one game that you lost, but maybe you won a lot of others. How satisfying is your family life? How rewarding are your friendships? How's your health? To move past the anger of losing, it helps to step back and view the broad canvas of your life. Money isn't the entire puzzle; it's only one piece! Look again at what you thought you wanted. Ask yourself, "Is that still how I feel, or have my priorities changed?" Maybe what you thought you wanted isn't really what you wanted, or maybe you can achieve those same things in another way.
Here is Dan's story:
- Dan: I retired with what I thought was a lot of money, and I had big plans to dabble in real estate and enjoy my avocations, which are very expensive pastimes. In this most recent crisis, my liquid assets and real estate plummeted, and my expenses went up! I was so stressed out about paying my bills that my hobbies no longer provided me with satisfaction. In fact, because of their expense, they were compounding my anxiety. I had to go back to square one and evaluate my life. I realized that my heart just wasn't in these high-powered activities any more, and I was actually relieved when I successfully abandoned them in favor of more volunteer work and time spent with my family. This change helped me get my finances under control and simplify my life. Even though this was a difficult experience, I consider it a win.
The score is about more than what happens when you're standing at home plate. When you're at the plate, all you can think about is getting a hit, maybe even a home run. But there's a bigger picture: what your fans are thinking about you, how valuable you are to your team, what kind of example you are to the sport, what kind of a student you are of the game, and how much you are enjoying winning. The end game is about so much more than that one big hit.
If you follow the right rules, you'll ultimately be a winner. You may win in a way that is far more important than the way you used to keep score. In adverse circumstances, when it feels that you're losing, losing, losing, you can start to feel like a loser. It's only when you lose the little stuff that you realize you may have been winning in a big way all along. You may also discover the potential to "win" in a way you had not previously considered. Develop rules that make sense for you and follow them. Give them time to work and reevaluate them when necessary. In the long run, following the right rules will bring you closer to winning.