Time to Check Your Pulse
The greatest enemies of an investor are expenses and emotions
— Warren Buffett
You’ve probably experienced it before — the overwhelming wave of relief that rushes over you when you manage to narrowly avoid a disaster. Maybe you hit the brakes or swerved away just in time to avoid smashing into another car. Or you caught yourself midway through a slip and avoided landing unceremoniously on the floor. Life is full of near misses and they happen in the investing world too — unfortunately many investors react in wrong ways when that happens; we have written before about how our instincts can make us poorer investors.
So if you are experiencing stress now that the market is very choppy, it is appropriate to stop and “check your pulse”. It makes sense to take a step back, assess your investments and perhaps take some extra precautions in case something similar happens and we overreact, making the wrong decisions — after all downturns are only a matter of time.
The best time to assess your true risk aversion is when you are going through a market sell-off, like what is happening now. Gauge your heart rate when you read about market losses — how do you sleep at night, knowing that your investments are underwater (albeit temporarily)? If you are losing sleep over this, then it is likely your asset allocation is not suitable for your demeanour despite your needs, goals and investing timeline. You will need to speak to your advisor, or if you are the DIY-sort, adjust it at the next appropriate juncture.
For a broad example of how asset allocations work, see diagram below:
If, during a market sell-off, you needed to dip into your investments to fund some of your financial needs, then it is likely that you did not build sufficient slack in your budget or did not create an emergency savings fund. Selling your investments during market turbulence is one of the worst things you could do.
Remember that large and long-drawn market sell-offs are typically associated with economic recessions. You could be retrenched or laid off for whatever reason. The last thing you want to do is to start dipping into your investments at a time when prices are depressed. As such, always have an emergency fund to cater for unforeseen circumstances. That’s why it’s called an “emergency” fund and we have detailed its importance before. A general rule of thumb is to have 6 to 12 months of expenses in this fund. However, for those who are a little bit more risk averse, it could make sense to even have 2 to 3 years of expenses in this fund just to play it safe.
Sometimes a near miss could create a false sense of security or even invincibility. You only need to trek back a little to the COVID-19 sell off in 2020. Whilst there was a very large and severe market drawdown, the recovery in stocks was equally quick.
Furthermore, all sorts of expensive and unconventional assets doubled or tripled in price during the recovery and in 2021.
Unfortunately, not all ended well.
This feeling of invincibility unfortunately could make an investor ignore future hazards, thinking that everything will eventually go up. This complacency can lead to painful consequences. Behavioural science research shows that investors wrongly attribute the positive outcome to their disciplined investing approach, when it was just pure luck.
Robin Dillon-Merrill, Catherine H. Tinsley, and Matthew A. Cronin. 2012. “How Near-Miss Events Amplify or Attenuate Risky Decision Making.” Management Science 58 (9): 1596–1613.
Robin Dillon-Merrill and Catherine H. Tinsley. 2005. “‘Whew! That Was Close’: How Near-Miss Events Bias Subsequent Decision Making Under Risk.” Academy of Management Proceedings 1: B1–B6. Briarcliff Manor, NY 10510: Academy of Management.
Like how you would seek a doctor’s advice when you have concerns about your health, seek financial advice from a fiduciary or independent advisor like us, to help you think clearly and make smart decisions after a near miss. A good advisor will help you make a plan that’s built to withstand market volatility and other near misses. To find out more, come and have a chat with us.
