Is your investment strategy based on a solid plan or hope?
In mid-October a client called in a slight state of alarm to discuss the recent pullback in the U.S. stock market. As a retiree, his main concern was if the markets continue to fall what will happen to his nest egg. At that time the S&P 500 stock index had fallen approximately 9 percent from its high in late September. The decline was all over the nightly news and all the talking heads were having a field day making wild predictions ranging from what we call “doom and gloom end of world scenarios” to more moderate, run-of-the-mill gyrations of the stock markets that soon will pass.
The conversation was an opportunity to reinforce the differences between an investment strategy with a plan of action vs. investing with a plan of hope.A plan of action has a predefined set of steps (buy and sell strategies) to take in response to both positive and negative market trends.
In the case of negative market movements, you employ your sell discipline; sometimes called risk management. Risk management involves defining a series of buy/sell indicators that drive your action. Based on factors that measure supply and demand levels, indicators help create exit points in a falling market. It’s like drawing a line in the sand for a particular investment. If the line is crossed on the downside the decision to sell is executed. Your risk tolerance and your overall temperament for portfolio fluctuations may influence exactly where that line is drawn. If you are a conservative investor your indicators may trigger getting out of the market sooner than someone who is aggressive.
On the flip side, you need to watch the same indicators for signs that the market has bottomed out and it’s time to start getting back in the game. In addition to defining buy/sell indicators, it’s helpful to rank various asset classes and sectors and have the willingness to rotate your money into those areas when they’re performing well. In most years the difference between the top-ranked sectors of the stock market versus the bottom sectors can exceed 50%. If you’re unwilling to establish criteria for when you’ll move your money in and out of them, you could end up leaving a lot of cash on the table.
An established plan of action with pre-determined buy/sell points – and adhering to the plan – is at the heart of a disciplined investing.
Without a plan or discipline, you’re left with a strategy based on hope – hope that the markets will stop going down, hope that a sector will turn around, etc. Grasping at intangibles like these often leads to either inaction or terribly misdirected action; neither of which brings you any closer to a comfortable retirement or provides a nest egg that will last throughout retirement.