Can't Be Said Enough

Yesterday I had a chance to chat with someone who would know and unfortunately a lot of financial advisory practices are hurting as a result of the bear market. I did not ask too many questions and won't violate the confidentiality of the conversation but I will make a couple of general points about this.

A couple of times in the last few months I have been in social situations and they go nice to meet you, what do you do, ooh how's that going? I typically word my answer about as follows.

Occasionally the stock market goes down a lot. Then a few years goes by and it happens again. You'll be OK if you can remember that.

I love the simplicity of that sentiment. Invariably no one is shocked by that idea and anyone at least participating in a 401k knows this. In my opinion it is crucial to prepare mentally well ahead of time for large declines. If you are a devout indexer or buy and hold it is probably even more important because your equity portfolio will feel the full brunt of the decline or very close to it. If you employ some sort of timing device for defensive action you need to be disciplined enough to heed your timing device when the time comes.

No matter which of the two camps you fall into it will be much easier to do what you need to do (either gritting your teeth or taking action) if you are not emotionally caught off guard. Just because you might believe no one can see bear markets coming does not mean they don't come.

This site gets both individual and professional readership. For professionals I would say the key is communicating early and often with clients one way or another about what to expect when a bear market comes. If you are a passive indexer you will likely drop 50% if the market drops 50%. Clients need to understand that long before it happens. Presumably you explained what you do and why when they hired you. You obviously believe in the way you do things but clients need to understand all the particulars head of time.

This is one of the reasons why I maintain this blog and wrote so much about bear markets and my strategy back in 2004, 2005, 2006 and 2007. A bear market will come at some point, this is what we will do (or not do) and this is why, a bear market will come at some point, this is what we will do (or not do) and this is why, a bear market will come at some point, this is what we will do (or not do) and this is why--if your clients read that enough times from you then the odds of them being caught off guard will be much less. Not caught off guard equates to less panic which is better for clients and easier for you.

For individuals, in addition to the above about preparing, I would repeat that big declines in the market are not your biggest problem. The market dropped 50% a few years ago and made a new high within the same decade. The market has now cut in half again and will make a new high again. The time needed to make that new high is the variable. The biggest impediment for individuals (but of course this applies to many professionals too) is human behaviors. Even the smartest investor will buy high and sell low occasionally or otherwise have some sort of emotional response to a market event but repeated behavior of this sort will do you in.

There have been several times that I have referred to various studies from mutual fund companies that go along the lines of the S&P 500 having 9-10% average annual returns, actively managed mutual funds having 7-8% average annual return and the individuals holding those actively managed funds averaging something like 3-4%. Human behavior in action.

I find the behavioral/psychological aspect of markets fascinating.