Visualize, if you would, the following scenario. You are in your early twenties, looking great and feeling great. You have on your best clothes and you are out at a local hotspot with your best friends. You have no idea what it is like to be 40, 60, or 80 years old. You do not know what it is like to carry the weight of responsibility of taking care of your children, business, mortgage, future saving and general life planning. You have no clue what it means to struggle with pain, disease or infirmity. But, there is a part of you that knows you are in your physical prime and everything is as perfect as it will ever be.
The music is playing and there are lots of other attractive people who are smiling, dancing and drinking. Everyone is having an all-around fantastic time. You can smell the people there -perfume, cologne and pheromones mixed with spilled beer and wine, with a thin whiff of disinfectant. Maybe it’s Pine-sol? You are even fairly sure that you can just barely perceive, albeit intermittently, the stale smell of an individual who had gotten sick. Someone had taken fun too far. Someone always does but on this occasion, it wasn't you.
The smell is so faint that your conscious mind is just barely aware of it. And it doesn’t make you sick; somehow it actually contributes to your smile. All this sensory input combines to form a promise. Tonight is going to be a great night. Everything, through the eyes of a twenty-something, seems perfect.
“FIRE”!!!Someone suddenly screams. The scream is so loud and shrill that you can hear it above the blaring music and din of a hundred conversations. Panic grips your chest and you break for the door, with the rest of the mass in a stampede. The people nearest the door get through but soon after there is a massive logjam of human bodies. Some folks are trampled. You are nowhere near the exit, but someone behind you tears your clothes and you feel crushed and suffocated by the weight of the crowd, desperate to save themselves at any cost. It’s difficult to breathe. Your mind flashes to mom-dad-sister-brother-bestfriend-dog-cat. It’s so hot. The press is now so tight that you can no longer raise even one of your arms. You cannot breathe.
Ok you can relax now. In this scenario, there was no fire. The fire department, EMS and police arrived, declared the scene safe and after a time, the people regained their composure and began helping the emergency responders with those that were injured. For the vast majority of people in attendance this will become an amusing anecdote “Remember the time when someone yelled fire - gosh were we scared! Hahaha.”
For a number of those who were torn at, trampled, and suffocated, however, it may be some time before they can shake the memory. Some few never will. Many may turn down future invitations to the club, dance hall, hotspot etc.
When we have an experience that injures or terrifies us we can develop a deep desire to avoid it in the future.
I guess if we could all behave rationally when a building is on fire, it wouldn’t be called panic. And if we could all shrug off negative experiences like a duck shakes off water, there would never be a need for psychologists.
This scenario shares a great deal in common with the psychology of market crashes. That includes both the crash itself and its after effects on the people who lived through it. Like the incident outlined above, everything seems perfect- until it isn’t.
The real estate bubble burst violently in 2006 and its shock waves cascaded through the stock market soon after. The DOW peaked just over 14,000 in November 2007. Over the next 18 months, however, Wall Street institutions like Lehman Brothers, Bear Sterns, and AIG sustained billions in losses from all the bad loans and financial products dependent on those loans that had been written in the decade prior.
People watched in horror as their retirement accounts plummeted in value. The DOW dropped by almost two thirds to just above 6000 in March of 2009. Soon after the market cratered Time Magazine ran a cover story titled, “The Death of the 401k” in which it described the 401k as a “rotten repository for American savings” and “an abject failure.”
The vocal chicken littles in the media were calling for a “double dip,” still greater losses after what they thought would be only be a brief rally. Few stopped to wonder where these so-called experts were just before the market crashed? Instead, Americans responded by liquidating their holdings and retreating to cash. A move that they hoped would protect their money from further loss.
Sadly, but perhaps not surprisingly, the media got it wrong again. The stock market never did “double dip.” In fact, it made a virtually uninterrupted march to new all-time highs where it sits as I write this. One tragic effect of all this was to cost people significant portions of their invested assets. I don't regard that as the worst effect though. The worst consequence was the aversion to investing that this gut wrenching and in some cases expensive episode had on the people who lived through it. Many haven’t returned to the stock market in any significant way. Some may never do so.
Once bit, twice shy.
The ups and downs of the stock market is known as volatility. Investors reaction to it has probably destroyed more wealth than all the bad investments ever made. How? By making people afraid to return to investing or to invest in the first place. Shakespeare wrote: “Our doubts are traitors, and make us lose the good we oft might win, by fearing to attempt.”
It is human nature to move toward pleasure and away from pain. By building financial mosaics we seek to diversify among asset classes and within asset classes. Moreover, we might consider investing in negatively correlated and non-correlated assets. Those are assets that tend (though are certainly not guaranteed) to move in opposite directions to the market as a whole, as well as assets that tend to move independently of the market, over time.
History has shown us that no portfolio, however well-constructed, can guarantee against loss in a falling market. But though history may not exactly repeat itself, I believe that it often rhymes. What I mean by that is that certain trends seem to flow from things that are particular to how the human mind works. Understanding those things can help give us insight, admittedly imperfect, as to how we might construct a plan to move forward.
Our insights may lead us to have an idea as to what is a balanced, sensible approach to risk management, which, we hope, can help us round out the edges of market volatility, reduce our anxiety and allow the better angels of our nature to prevail when things get scary.
To learn more about strategies that might help toward reducing volatility in an investment portfolio, there is abundant literature on the topic which you might want to familiarize yourself with. So too, you may want to consider speaking with a financial planner whom you trust. Consider what a prudent way forward is. Then take action.
Scott McGimpsey November 25th, 2016
This material was prepared by Scott McGimpsey and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy. Neither Summit Brokerage Services Inc. nor Scott McGimpsey is engaged in rendering legal, accounting, or other professionally services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty. Moreover, a diversified portfolio does not assure a profit or assure protection against loss in a declining market. UNIFIED PLANNING GROUP is an independent firm with securities offered through Summit Brokerage Services Inc., Member FINRA, SIPC