(What You Already Know About) What to Do When Markets Sell Off
Recently, Vanguard’s Chief Investment Officer Greg Davis published an article representing the firm’s guidance to investors on how to react when markets fall in value. What’s most notable to us is what they don’t espouse in such historically common conditions. Missing is such “wisdom” as “look for quality names to pick up at more attractive valuations,” or “buy out-of-favor ‘value’ stocks whose price-to-book ratios are below their 52-week average,” or “shorten up on the yield curve.” A mutual element in each of these commonly disseminated investment “gems” is the presumption that you were able to make such prescient moves in advance of the present time (and that once you’ve completed these time-bending steps, you’d have the foresight to jump in time ahead of the next change in market conditions and profit from your next specific hot moves). Though popularly promoted for decades as the purview of smart investors, such timing maneuvers are no more likely to produce above-average returns than flipping a coin repeated will result in heads coming up more than 50% of the time.
Instead, what Mr. Davis and his team at Vanguard advise is to do…essentially what they’ve always been guiding us to do: choose an asset allocation of stocks and bonds specifically suited to your individual situation; invest in diversified, broad-market, low-cost funds; remain patient and resolved as markets rise and fall; and rebalance periodically. In other words, your solid, comprehensive preparation was your work. Now what’s required of you is to trust your groundwork, remain faithful to your long-term plan, and be measured in your emotions. Rudyard Kipling’s poetic guidance remains fully relevant to this modern era of investing: “If you can keep your head when all about you are losing theirs,” you will indeed separate yourself from the majority. For many “experts,” on financial talk shows and online, will speak of great danger, and by implication, that all who do not “do something” are fools. It can feel as if the weather report keeps warning of heavy rains, so we feel foolish if we do not grab for a raincoat. In this regard, the farmer’s view should be the long-term investor’s view: he or she does not attempt to protect the fields from the rains. Indeed, though no work can be done in the fields in the downpour, we know that it is necessary to sustain future growth. As investors, while we don’t root for market’s declines, we need to frame them properly. When we invest money, it is future appreciation that we seek: the notion that our money, allowed sufficient opportunity, will be worth more in the future, enabling us to do more, after considering inflation, than we’re able to do with it today. This is what market declines provide: a wider gap between current valuations and expectations for future valuations – greater appreciation potential.
Why do most investors not earn returns as robust as the market’s? Among the reasons is a temperament ill-prepared for such discipline. Selling in declines robs us of that opportunity to have more invested at the market bottom, and thus missing some of that tantalizing long-term appreciation.
How to best treat unsteady markets? Review your broad asset allocation with your adviser. Then, set aside enough cash to live on for a period of months, if need be. This minimizes your likelihood of being forced to sell out of those “improving” valuations. Additionally, it could even afford you fresh money to invest as those around you begin really losing their heads. At which point you will feel justifiably smart for your measured, balanced patience. Bravo.
