Unless you’ve been living in a cave the last week, you’ve probably heard a great deal of news and opinions about the vote in Britain to leave the European Union. And even if you managed to completely avoid the news cycle, perhaps you took a peek at your investments and wondered what was going on. Clearly international events are affecting the markets, the future looks quite uncertain, and many investors are in an emotional whirlwind.
Rather than add to the pile of opinion pieces pontificating on the uncontrollable, I thought I’d take a moment to focus on what we as individual investors can learn from this situation and how these lessons can be used to improve our personal portfolio choices. I have no earthly idea how markets will react to this news over time, so let’s talk about something a little more close to home — how you react to unexpected market adversity.
Stressful times have a way of bringing out the emotions even in otherwise completely rational people. I remember at the funeral of my grandmother that some family members were angry, some were quite down, and some seemed strangely happy. I don’t think any of those reactions were wrong — they were just different. We all handle negative events differently, and understanding that truth is an important growth process in emotional intelligence and self-awareness.
When the market gets a big jolt like it did on Friday and will likely to continue to experience as events unfold, emotional reactions are similarly mixed. Some people are angry, some are negative, and some are happy. Where you personally fall on that emotional spectrum explains a lot about your relationship to your asset allocation, and by acknowledging these emotions you can identify a few simple steps to strengthen your financial resiliency.
Anger
One of the immediate reactions I’ve seen over the weekend to the election results and subsequent market fall is one of contempt for the voters who made this choice. How can they be so foolish? Things were going great and they ruined it!
But here’s the thing about anger in investing — the angriest people are often the most shortsighted. If your portfolio success truly depended on things going exactly how you predicted them to, perhaps the problem is not the markets but your own over-confidence. Even if the market choice is indeed objectively poor, to assume that your investment decisions should not account for the possibility of poor choices by others betrays a touch of naivete.
What can angry investors learn from Brexit? The markets are unpredictable and may not behave in a way that you personally find rational. Plan accordingly. Maybe that means not putting all of your eggs in one basket. At the very least, take the time to anticipate things not going your way and to work out contingency plans. Like a basketball team that scores while an opponent is arguing a foul call, if you prepare yourself for any outcome you can profit while others lose their cool.
Negativity
Perhaps the most prevalent reaction in the financial media is one of profound negativity that manifests in anxiety and fear. In a classic example of journalistic herd reporting, a cursory search of “Brexit Bloodbath” generates a pretty remarkable 312,000 hits this morning. And judging from the trading volumes on Friday, a great many investors were racing to the market exits.
So Friday must have been a terrible day across the board, right? Well, the stock market is not the only market. Anyone with a more diverse asset allocation just saw a normal run-of-the-mill day. While European stocks fell over 11%, the US stock market was down just under 4%. Even with a good chunk of international stocks, the Three-Fund portfolio lost less than 3%. The Golden Butterfly finished the day basically even like nothing at all happened. And the Permanent Portfolio actually gained 1%.
Heavy stock investors sometimes wonder why anyone would invest in long term treasuries and gold, and Friday was a nice example. While so many people were feeling panicked and wondering what to do next, anyone with more diverse asset allocations including these classic flight-to-safety assets just enjoyed their cup of coffee like any other morning.
What can upset investors learn from Brexit? Perhaps your risk tolerance is not as high as you previously believed, and a more balanced portfolio would serve you better. It’s also a good time to survey the assets that thrive when stocks take a hit, and to consider whether adding a bit of those to your own portfolio makes sense. Make it a goal to be prepared for the next unforeseen market swoon so that there will no reason to be upset. The less likely you are to sell, the more likely you are to be a successful long-term investor.
Happiness
Perhaps as a reaction to the negative investors, I’ve noticed a surprising number of seemingly giddy investors on a few message boards. Hooray, stocks are on sale! I love it when markets tank so that I can buy more!
This is a decidedly better mentality than running for the hills out of fear, and I appreciate the constructive mindset and how it encourages people to stay the course. However, I personally see a few drawbacks to this unbridled enthusiasm.
First, taken too far it has a tendency to fetishize losses (steeper losses are even better sales than shallow losses!) and encourage unnecessary risks and ultra-volatile portfolios. As I’ve discussed before, you don’t need to load up on risk to improve your returns. The idea that those who take more risks always get better returns is based on a false assumption, and celebrating losses reinforces a potentially dangerous mindset.
Second, excitement about market turmoil all-too-often feeds active trading instincts. Many stories of Brexit happiness I’ve seen were followed by tales of ditching asset allocations to try to make big money by timing the bottom. While this may possibly work out, it also negates the warranty on the portfolio and exposes investors to unnecessary future risk when they finally realize that bottom isn’t so easy to predict.
And finally, the idea that stock sales are always good — even if your own portfolio took a huge hit in the process — may be true for young people with stable jobs, long-term investing horizons, and no immediate need for that money. But retirees or parents with impending college tuition bills may feel very differently. So it’s great to be happy that your next paycheck will buy more stocks, but please be sensitive to other people with bills to pay out of their investments who naturally aren’t so enthusiastic.
What can happy investors learn from Brexit? Be thankful that you’re able to buy more stocks at a discount, but seriously consider the concerns of people in other life situations where it isn’t such a positive development. That person may eventually be you, and the best time to plan for that situation is not after it happens, but before.
Apathy?
So if all emotions have their downsides, does that mean that we should aspire to be investing robots with no feelings whatsoever who only make decisions based on pure logic? Nah. While it sounds nice and makes for interesting Star Trek characters, it’s just not practical. Humans are inherently emotional beings, and to ignore one’s emotions also ignores natural defense mechanisms. Anger, fear, and happiness exist for a reason, and usually it’s important to pay attention to those instincts.
Ultimately, the issue is not the emotion itself but how you react to it. It’s normal and healthy to fear large losses or to be happy when an investment goes your way. But the investor who is attuned to the lessons that his emotions teaches him today and who proactively adjusts his portfolio ahead of time to minimize mood swings in the future will be much better off than one who only reacts to the markets after the fact.
That last point is important enough that I’ll repeat it. Don’t overreact after the fact. Hasty portfolio changes in the height of an emotional swing of any type rarely work out well in the long run. Take the moment to learn and to plan, but act later when emotions have cooled.
Ultimately, the plan is the key to success. Brexit only makes for emotional times for those who were unprepared. No matter how this one perceived crisis pans out, there will undoubtedly be more in the future. Take the opportunity from this event to learn more about yourself, the markets, and the benefits of asset allocation to your own financial and emotional well-being. Your future self enjoying a peaceful walk outside while people around you are so emotionally invested in things they can’t control will thank you later.