As an investor, you are bound to run into tough periods. There is no running away from that. For seasoned investors, this usually does not pose a problem, as most have already developed a rational plan to deal with such situations. They know they just need to stick to it. But for those who are new to the world of investing, I can assure you that there will be gut-wrenching moments where you just feel like throwing in the towel. And more often than not, the reason behind this instinctive urge is to avoid the pain that comes with the fear of losing. This single reason often overrides everything else.
However, it's crucial to recognize that investing is not just about reaping rewards during good times; it's also about weathering the storms that come your way. If you cannot overcome your own emotions, then even the best investment strategy in this world will not work.
In this post, we'll share a few practical tips that you can take to navigate through such times and ensure that you emerge stronger and more resilient.
1. Diversify - your good old advice and your only free lunch
Diversification is the bedrock of a well-rounded investment strategy and a statistically proven way to grow your wealth. Contrary to what many people believed, if done in the right way, you can even generate returns that beat the stock market over the long run.
And by diversification, I don’t just mean spreading your bets across a few stocks. What I mean is multi-level diversification across securities, asset classes, and uncorrelated strategies. Such a portfolio not only delivers more consistent returns, it also holds a much lower level of risk. This means losses are likely to be much lower when a rough patch hits providing you the peace of mind. And as long as you can keep the losses within your tolerance limit, you are less likely to act on impulse.
Past Posts on Diversification:
2. Understand your strategy and the premise of the trades well
Before you invest, it's essential to have a clear understanding of your investment strategy and the underlying rationale behind the investment decisions you make. A well-defined strategy serves as your roadmap during tough times.
And why is that important? As an analogy, picture yourself as the captain of a ship. Will you venture into the ocean without charting a course and contingency plans and hope that you will somehow be able to survive whatever comes your way? If that is your approach, then you will surely panic when a storm hits. That is also the time when calmness and clarity of thought are critical.
Just like a seasoned ship captain, a successful investor needs to plan ahead and have a strategy to deal with the challenges in the market. And equally important, you need to know why you are taking those actions. This is what gives you the confidence to follow through with the plan in turbulent times. Even when you are plagued by doubts, asking yourself a few simple questions will often do the trick:
1️⃣ Is the fundamental premise of the strategy broken?
2️⃣ Does the behavior of your strategy deviate significantly from historical patterns?
3️⃣ Are the losses much deeper compared to previous instances?
4️⃣ Is your strategy taking considerably longer to recover than it has in the past?
These questions serve as a litmus test, helping you evaluate the integrity of your strategy and make informed decisions. If you'd like to delve deeper into this topic, you can find more details in the linked post here.
3. Patience... Have a long-term perspective
Patience is key when it comes to many things in life. Investing is no exception. But for sure, there will always be those who choose to be fixated on short-term price swings. It's only natural. We all aspire to have positive outcomes, and we want them fast. But while there are profitable short-term trading strategies, most are beyond the reach of typical retail investors due to constraints such as time, expertise, and resources.
Numerous studies have also shown with glaring statistics that it is a bad idea to view the market as a path to get rich quickly for a host of reasons.
So, don’t be too quick to dismiss longer-term strategies and instead stretch your investment horizon further out. Many such strategies have the potential to yield positive outcomes. They do, however, need time to pan out. When you adopt a long-term perspective, it can also help you avoid emotional reactions to market volatility. And do not underestimate the power of compounding. Over time, it can have a significant positive impact on your investments, provided you stay invested.
Remember that investing is a marathon, not a sprint. Stick to your long-term objectives, and don't let short-term turbulence derail your strategy.
Read about the impact of long-term investing:
4. Know yourself well and set realistic expectations
Most people focus too much on the market and too little on themselves. And that lack of self-awareness is a big challenge in its own right. Undoubtedly, knowing the market is pivotal because it gives you a good sense of what is realistically achievable and the trade-offs involved. However, you will still need to embark on an introspective journey to comprehend yourself fully. This self-knowledge is the compass guiding you toward achievable investments that align with your unique style, risk tolerance, and return expectations.
Everyone is different. On one end of the spectrum, there will be conservative investors who are content with modest single-digit returns as long as their capital is secure. Then on the other end, there are individuals with aggressive appetites who aim for high double-digit returns and are ready to stomach deep interim losses. Most of us fall somewhere in between. But the bottom line is that you need to find out where you stand in terms of your risk tolerance, return expectations, and investment timeline so that you can choose the right investments. Just like picking a job that you are not suited for, making an investment that doesn't fit your profile can come to a premature end before any rewards can be reaped.
5. Look at your entire investment portfolio as a single product
A well-diversified investment portfolio constructed on sound principles and strategies should be seen holistically as a single product that comprises different securities. These can be stocks, bonds, futures, options, FX, commodities and REITs. At any one time, some may be performing while others are not. That is how it should be.
But based on what I have seen so far, people like to break the portfolio down and start to focus excessively on the individual components rather than the portfolio as a cohesive whole. When a specific security goes south, they will be tempted during trying times to take "emotional" actions such as cutting those positions or allocating more to others. Now, if these actions are not part and parcel of what was the original plan or strategy which should have already been thoroughly researched and tested, then what they are doing is introducing untested elements to a working strategy. This is often a recipe for disaster and often causes more complications down the road.
Therefore, learn to look at the "big picture" and see your portfolio as a single integrated product. Achieving this perspective links back to the earlier point I made about having a comprehensive understanding of your overarching portfolio strategy. In doing so, you enhance your ability to resist impulsive actions that might undermine your well-established investment approach.
6. Learn from and keep in touch with the market but don't trade the headlines
The fastest way to grow your understanding of the market is to be in it. Nothing beats "On-The-Job Training" when it comes to learning. That means constantly educating yourself, keeping abreast of the news, and latest developments, and observing how asset prices move and their impact on your portfolio. The more you see, the more you will be able to tie market events and regimes to asset behaviors and your own portfolio's performance. And the less you will fear when your portfolio goes through a drawdown. Because you know why it is happening and you are confident it will pass.
But unfortunately, for those who are still new, that means you have to resist the urge not to give in to knee-jerk reactions to every headline that comes along. Headlines often over-sensationalize things because their objective is to get people to read what they wrote. The world will not end simply because a journalist or someone writes like it will. This is a rite of passage. I won't say it is easy but it is something all serious investors go through.
7. Dollar Cost Average if putting in big lump sums makes you uneasy
Dollar Cost Averaging (DCA) is a strategy that involves investing a fixed amount of money at regular intervals, regardless of market conditions. It is a well-known and popular approach. Rather than investing in big lump sums, doing it in regular bite-size seems to gel with many people. But having said that, it is not a magic formula for superior investment performance. There are drawbacks. However, it does help to foster discipline and consistency to overcome emotions.
If you would like a more thorough treatment of Dollar Cost Averaging as an investment methodology, you can read the post below.
Conclusion
In the world of investing, tough periods are inevitable. They test your resolve, patience, and discipline. However, with a well-thought-out strategy, diversification, and a commitment to your long-term goals, you can navigate these challenging times successfully. Avoid getting swayed by headlines, and short-term price moves that prompt you into irrational knee-jerk reactions.
Stay focused, stay disciplined, and stay the course.
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