The Philosophy of Nada

It is Monday morning and the world's stock markets are falling drastically. Starting in Asia overnight and then hitting the US markets in the morning. The news is all doom and gloom. Your neighbors, co-workers, and that really smart friend or family member are saying this is it - Sell, get out of the market, this is the end! Is it August 24, 2015?

No it is October 19, 1987 and you are in the middle of Black Monday when the stock market fell over 22% in one day. A record number of investors sold and bought five-year CDs paying about 7% per year. Meanwhile, inflation averaged about 5% per year during the same period. Your after-tax, inflation-adjusted return for the five years was about 0.50% per year. During the same five years the stock market returned an annual average return of 14.50%, or an after-tax, inflation-adjusted return of about 5.50% per year. That is 5% more return per year for doing nothing. Nada.

So assuming you had a diversified portfolio, doing "nada" (nothing) and riding it out was the smart thing to do. The even smarter thing to do was to buy in to the market when it was going down. In fact, for every market sell-off, market correction, and economic recession since 1987 the smart thing to do has been to do nothing and buy in to the market on the way down. If this is true, why does every fiber of our being tell us to do something and sell?

There is a physiological reason for our panic response. Deep in the limbic part of our brains is the amygdala. It is what produces the "fight or flight" response that was critical to survival, but can push people to do something, anything, rather than keeping a long-term plan in place during times of adversity. If you have an overactive amygdala, you may have a lot of anxiety today.

So you may be thinking, hey thanks for the physiology lesson, but what should I do now?

Here is the best advice I can give you when the markets are falling and the financial news media is flashing blood-red "Breaking News" banners. Follow these seven things at all times and you will get through tough times in the markets with less pain. 

1. Take a deep breath and do nothing. Kafka said, "All human errors are impatience, a premature breaking off of methodical procedure, an apparent fencing-in of what is apparently at issue." Our clients have an Investment Policy Statement, a "methodical procedure" that drives our investment decisions. The Investment Policy is designed for all market conditions. What is happening now is perfectly normal, and is a necessary component of the stock market's risk and return paradigm. This week and this year are well within normal expectations. The markets are not abnormal, but our perception of what is happening is abnormal - an apparent fencing-in of what is apparently at issue. Being impatient and doing something rash is "reactive." However, being patient and doing nothing in times of crisis is "proactive". Doing nothing can be a very deliberate decision at times. 

2. Turn off the media. Unlike 1987, we now have 24/7 access to television news and internet chatter about financial markets. It takes very little effort for someone to voice or post an opinion about the markets and no one monitors these sources for accuracy and consistency. It is all noise and entertainment and has nothing to do with your financial plan. Watch it for a while if you must check in, but if you feel anxious, turn it off and proceed to step 4 below.

3. Don't listen to that really smart friend or family member. One of the most common mistakes is to believe that someone on television or a really smart friend knows what is best for you. Everyone has a bias, and if you think someone has a corner on information or has the ability to predict the future, your problem isn't with the financial markets. 

4. Take a walk, run, or bike ride. A lot of academic research shows that when we are suffering from an overactive amygdala and feeling panic in a situation, physical exercise is one of the best treatments. Getting outside and moving not only helps you physically, but it helps you mentally. It doesn't need to be intense. Simply moving and being outside will help a lot. You can get similar results by cleaning the house, organizing the garage, or fixing that leaky faucet. If you are not capable of physical exercise, try reading a novel, baking a cake, or writing a letter to a friend about how much you appreciate them.

5. Unless you desire more risk than the general stock market, avoid buying individual stocks. When the stock market is falling, many individual stocks will fall more than the market. The term for this is beta, how much an individual stock moves compared to the general market. There is significant evidence that consistently picking individual stock winners is extremely difficult and rare, but most individual stocks carry considerably more risk in down markets. If you want to increase your odds of success with less risk, a diversified collection of stocks in a mutual fund or ETF is the most efficient way to get the return of the market with a little less risk.

6. Always own bonds and stocks. The risk of rising interest rates should not outweigh the benefits of owning bonds when the stock market is falling. Owning bonds is a natural hedge against the risk of owning stocks. 

7. Rebalance your portfolio when the markets move a lot. When the stock market moves a lot, either up or down, it is a good time to rebalance your portfolio. The only "action" that will provide value over the long-term is to rebalance when your portfolio has shifted significantly from your target allocation. We monitor this for our clients and take action when we believe the client will benefit from the cost of trading to realign the allocation of the portfolio. We have set tolerances for the allocations and take action when necessary.

These are the steps we want you to take when markets are doing the crazy things that they sometimes do and we have to remind ourselves of the same things at times. While we don't think it's beneficial for you or us to pay too much attention to the markets at these times, rest assured that we are monitoring the situation and will make changes if and when we think it is needed to help you meet your long-term goals. Should you have any questions about the markets or how it impacts your long-term plan, don't hesitate to reach out to your advisor. 

Reed C. Fraasa CFP®, AIF®, RLP® is the managing partner and financial planner at HIGHLAND Financial Advisors, LLC.

As always, seek professional advice from your comprehensive financial planner before taking advice from the internet. For more information about HIGHLAND Financial Advisors, click here, or sign up for our newsletter below to get our updated articles.