Maybe A Second Cup Of Herbal Tea?

Yesterday's post was a reminder about how volatility tends to work and about letting the market do its thing for your account over longer periods of time. The post made a critical assumption that I'm surprised no one noticed. I didn't even think of it until I was shoveling slush in the pouring rain yesterday.

All the talk about keeping emotions in check and looking at results over a full stock market cycle assumed the correct asset allocation. The extreme volatility of last couple of years has hopefully taught people a thing or two about their own tolerances. Ideally this would have happened ten years ago, the first time in recent memory that the US stock market cut in half.

There have been a couple of times since March, well off the bottom, where I rhetorically asked to think about your mindset back in March. What number did you say if I can only get back to $x then I'm gonna fill in the blank (cut back, get out, whatever). First of all if you had this sort of conversation with yourself then there is a good chance that you have too much in equities or had to much if you have since sold down your exposure.

A useful thought for this discussion which I just mentioned the other day is from Nassim Nicholas Taleb. To paraphrase; if people understood the risks of investing in the stock market they would never do it.

I don't believe this is a practical concept for financial planning but it serves as a bit of a building block for an investing philosophy. Another building block at the other end of the spectrum is that from a numbers standpoint there is an argument to be made for 100% equities all the time. I don't advocate that for several reasons but there is an argument there. Yes the last ten years have been bad for equities, well actually no, the last ten years have been bad for certain equities. The oughts were not the first decade where stocks "did not work" but I do not believe for a moment they are permanently broken.

You all probably know the behavioral finance nugget about negative emotions from losses being far more powerful than the positive emotions that come from stocks going up. People tend to forget about the negative emotions they feel when the market is down a lot or when their picks are not working out.

For those of you that did bargain with themselves as described above, did you remember that you did so before I mentioned it above? I have known people older than me that freak out every time the market goes down some and simply are incapable of remembering that this has happened before. The reason I mention them being older than me is that they have been through more big declines than I have yet they cannot remember what it felt like before and can't reason what happened after. I can promise you that you do not remember every fast decline that you have lived through as an investor.

This line of thinking has influenced me in what I do for clients and what I do in our personal accounts. Getting defensive upon a breach of the 200 DMA is driven off of this subject; that is trying to avoid getting to the point of emotional desperation.

Figuring out the right target for you may not be easy. It is a marriage of how the numbers work with your ability to sleep or in the context of this week's posts not have your day determined by how your portfolio does.