Resilience

Investing is like life itself; wishing to avoid periodically going sideways or backwards is not realistic. Rather than seeking to avoid all hardship or setback, we should instead focus on developing stronger resilience.

Peggy and I have just spent the past couple weeks watching tennis from the US Open in New York, happily recounting the days I would spend there as a youngster taking in the spectacle. I ask you: do you think players walk onto the court believing that they will win every point in the match? Hardly. Do they have a belief that they will prevail in the end? Hopefully. One of the two players will lose the very first point; the first game; even the first set. Setbacks, for sure; but never a possibility which was not accounted for. Instead, he or she relies on their experience: “I’ve dropped a first set before and won plenty of matches.” Possibly even on this court. Or against this particular player. “I will not be undone by individual setbacks, or even by downhill momentum, possibly exacerbated by adverse fans.” It’s telling that top-ranked professional tennis players now often have among their team a psychologist or mental strength coach. These athletes understand the value and the power of perspective and resilience.

We need look no further than the people of Ukraine as an inspiration for resilience. The hardships they have and continue to endure are greater than those which many of us will likely ever need to face. We are only beginning to appreciate their fortitude, resolve, and resilience. Likewise, we are moved by the strength of the survivors of 9/11 and their families.

Peggy periodically recalls the words of her drill instructor: “If you’re in a knife fight, expect to get cut.” The lesson? Don’t let a predictable element surprise you. Or as Buddhism would teach us in the principle of non-attachment, try not to attach goodness or badness to an outcome: just let it be as it is.

Investing in 2022 has included various forces sufficient to jolt investors from their solitude, among them inflation, foreign wars, political disruption, even increasingly variable and negatively trending climactic conditions. The market knows that disruptions will occur, sometimes parading in small quantities as a gentle drumbeat, and at other times in large clusters sufficient to make a loud “boom.” As a forecasting mechanism, capital markets know that every future economic factor will not improve uninterrupted forever. This is what is meant by certain news being “priced in” to asset prices. I like to say that the market (meaning all global investors who constitute the stock and bond markets) doesn’t so much care as to the specific disappointment. They simply factor in that there is a detracting variable to their asset pricing modeling: uncertainty; or better framed: certainty of adversity. So when I’m asked whether I think the market will rise or fall based, for example, on the prospects of a particular US presidential candidate or political party, I am quick to reply in two ways:

1. Markets are dynamic pricing mechanisms, meaning that like sports betting books, they are ever changing their assessment of two central factors: the perceived likelihood of a particular outcome, and the perceived severity of that outcome. If you’ve ever watched an online app such as ESPN during the later stages of a baseball game, you’ll see that when a home team is leading by 7 runs with two outs in the bottom of the ninth inning, their predicted win percentage is 99%. Electoral races are also being re-handicapped all the way up to election day. The odds of a particular outcome are being recalculated into asset prices all through the campaign season.
2. Political considerations of any one country, even our own, constitute only one of many variables which would affect stock and bond market pricing. This is where we need to be risk analysts. And honestly, the list of known, material risks to equity and fixed income markets is vast. New data showing weakness in monthly durable goods orders or weekly unemployment claims; Federal Reserve policy actions; any such newly-perceived patterns are among the known risks. There is an even longer list of essentially unquantifiable risks to markets which would be nonsensical to attempt to enumerate: what if a natural or man-made disaster crippled a nation’s capital; or on the positive side, what if a method to produce cold fusion were to be developed and quickly commercialized? The vast number of possible scenarios could keep even the finest worriers among us up late into each night.

My point is that we simply need to recognize that there is and will be a pool of risks. And also a pool of beneficial developments. We don’t much need to identify and fear each one; we just need to appreciate that there will be an ever-present collection of them.

Perspective is a key element of resilience. We know, for example, that inflation at current levels is likely not systemic. Historically, it has ebbed and flowed, as anyone who remembers the late 70’s/early 80’s can attest. At the opposite end of the spectrum, students of Japan’s economy over the past 30 years know that inflation can actually stagnate at stubbornly low levels. Data compiled by Yale University economist and Nobel Prize winner Robert Shiller indicate that the average annual inflation rate in the US from 1871 to August 2022 is 2.27%. Would we be wise to presume that inflation will be concerningly high at various future times? Yes. (Though probably not always.)

As people, we would do well to develop better balance. We can enhance this physical attribute through various disciplines such as yoga, for one. As hockey players, we skate with our legs slightly wider and our knees slightly bent knowing that getting hit (or initiating a hit) is simply an eventuality. We won’t be surprised by it, and we’ve developed physical resilience to mitigate its impact. This autumn we will be overseeing an earthquake retrofit of our home. In each of these cases, we’re strengthening ourselves, preparing.

In a broader sense, we develop resilience through our accumulated life experiences: parenting, career, military experience, long-term friendships, marriage, and so on. We become more broadly able as a result of this collection of events – good, bad, and indifferent. For me, this “portfolio” of experiences included my eight years away at school, from high school and college to a year and a half overseas. These included some “character-building” times. Numerous things were not as I’d wished or expected. Why, for example, in Britain would I turn a light switch down to turn on a light? Or why would the bathroom mirror be located on the wall behind the bathroom sink. Shaving was interesting there. Learning to successfully navigate these varied environments built my confidence to take on challenges into the future. I call this compilation of experiences my Education, a portion of which was my formal education. As you contemplate your own life’s narrative, give yourself some credit: if you’ve lived into or even well into adulthood, you’ve grown immeasurably from the varied experiences of your life, some of them even ones we chose. We are an adaptive species, as our individual stories substantiate.

We also learn to steel ourselves to the prospect of outright pain. In his poem Desiderata, Max Ehrmann wrote: “Nurture strength of spirit to shield you in sudden misfortune.” (That entire poem is a wonderful teacher.)

In addition to the mental/emotional fortitude we nurture, we can also implement specific elements of financial resilience to our money. One of these is our oft-touted diversification. Consider a large table with multiple legs underneath it. If any one gets damaged or even severed, the weight of the table is likely still carried by the multiple remaining legs. Small cap stocks taking it on the chin? Government bonds are likely performing somewhat differently. We spread our money across not only broad asset classes according to an individual’s appetite for relative safety or risk, but we own those entire asset classes, not narrowly-focused bets on specific companies or conditions. We don’t need those table legs to look particularly sexy; we need them to carry the full weight of the table, even if the floor should shake. Further, we seek tax-category diversification to the degree possible: maintaining a balance between taxable, retirement, and even Roth assets adds to financial flexibility, which is a form of resilience. And don’t discount the role of cash in financial fortitude. As a component of the asset class spectrum, the ability to draw from cash rather than fluctuating “riskier” investments adds to our ability to weather difficult market conditions.

Financial resilience also includes tuning out the noise: turning off the TV; not following social media for “investment” guidance/ideas/tips; not being concerned with other investors’ new-found methods for wealth, whether friends and relatives or strangers.

Remember: investing is a demeanor; it is not an exercise of constant motion. “Don’t do something; stand there,” in the words of John Bogle, founder of Vanguard. It is a firmness of position, complete with the confidence that through vision, execution of your plan, and dedication to the long term, you will earn the benefits which the markets offer.

What is not helpful: trying to out-maneuver market vicissitudes. Remember the idea I described earlier that the market is a real-time aggregate risk analyzer? Humility is the watchword here. Your car comes with a steering wheel for a reason: manufacturers know that the road will include turns. We drive with our hands ready to simply steer through them. Oversteering, however, is not beneficial. Leave the perceived shortcuts, cute tricks, and hyped stock ideas to people who think that all their maneuvering, accelerating, decelerating, and lane changing will get them to their destination materially faster or safer.

If we’ve all learned anything over the years, including these past few, it’s that life is ever-evolving. We expect tomorrow to be different from today, in both anticipated and unanticipated ways. Mark Twain wrote: “History doesn’t repeat itself, but it often rhymes.” We can grow to expect rhythms. Then we will be well-balanced to handle for the shifting environments which will come.