Keeping a Level Head in a Down Market - Should you Stay the Course? |
13 Comments |
|
Recently, Trent from The Simple Dollar, one of the best personal finance bloggers I read wrote, Basic Investing In A Down Market (Or Any Time You Feel Nervous). In it he too a question from a reader, Lila, who was nervous about her 401K investments in this market. Trent suggested that she sell her holding and wait out this wild market.
JLP of All Financial Matters wrote a follow-up article on it, saying that Trent let him down. JLP is of the opinion that one shouldn’t try to time the market and selling in the face of fear is not the right plan for a 401k plan. A fabulous, though heated, discussion ensued in the comments of JLP’s article. It seems that the two bloggers, who I both read can’t agree on one small point. How much should psychology play a factor in personal finance?
I understand where each blogger was coming from. Trent at The Simple Dollar simply realized that Lila was uncomfortable with her current investment. Positive things rarely happen when you force people to do something they are uncomfortable with. If she gets out, she can cut her losses, and then re-evaluate her reasons for investing to begin with. I also understand where All Financial Matters was coming from. He pointed out that since it was a retirement account with a 20 year horizon, the fluctuations of this month are not going to be a significant factor when it’s time to retire.
So, what’s the answer? I believe that both writers would agree that investing in common stocks (or mutual funds) is one of the best ways to build wealth. Lila will likely have to work harder, smarter, or longer if she decides that she can’t tolerate the risks of short-term loses of various investments. Assuming that she doesn’t want to work extra, she may be best served by developing the mental fortitude to tolerate mild or moderate investment risks.
How does one develop mental fortitude? It differs for each individual. A mother bird throws a baby bird out of the nest to try to teach the baby to fly. Trent brought up another analogy. He suggested that someone afraid of roller coasters might start out on a log flume and gradually work his/her way towards roller coasters. This is a great time to not take personal finance personally and conquer those fears. One way to do that may be by trying to diversify oneself outside the United States. I thought this was a prudent plan back 3-4 weeks ago when I suggested a higher international asset allocation might be prudent.
When I was learning how to drive, I would look at the road 5-10 feet in front of me. I found that I couldn’t anticipate the turns coming up. It lead to over-steering and I found myself swerving all over the world. I quickly learned to drive to by keeping my eyes focused a ways down the road. I’ve learned to invest the same way. I can’t look at just 5-10 feet in front of me and react - I need to make decisions based on how the future looks. This month’s loses have no effect on that outlook.
This post deals with: ... and focuses on:Psychology
Stumble
Reddit
Digg
Del.icio.us
PropellerLearning math early helps you invest later! Look into helpful math games to teach your kids about financial responsibility. Someday they'll have to finance their college education and scoring high on math exams helps a child succeed. Get great math help today!
Next: Genius Types: A Site I Think You Will Like
August 28th, 2007 at 6:01 am
Lazy Man, you are wiser than your name implies. Great post.
August 28th, 2007 at 7:09 am
Thanks, Trent. I took the risk of trying to look beyond the suggestions, into the thoughts behind them. If I was wrong, it could have gotten a bit ugly.
I didn’t think the name of Lazy Man had any reflection on whether I was wise or not. In fact, my laziness for doing other more physical activities has lead me to use the time in mental pursuits.
August 28th, 2007 at 6:55 pm
Laziness along with necessity are the mother of invention.
August 28th, 2007 at 8:08 pm
It seems to me Lila’s biggest problem was that all of her eggs were in one basket. Diversification would really help her through the rough patches.
August 29th, 2007 at 2:38 am
People should think twice before they invest their money.
When you invest in the market you will suffer “potential loss” once in a while. It’s the same story since the market exists. People that are not comfortable with these kind of fluctuation should not invest money in the market (or blindly invest in money market while inflation is grabbing over their yield).
I agree with Lazy, if one is not comfortable with something, there is no point of forcing her to keep her position in the market. However, the price to pay for her fears will be less money at her retirement. Personal finance is more related to psychology than we could think.
August 29th, 2007 at 2:40 am
What would be really interesting would be if Lila resurfaced and threw in her two cents about the advice she got from Trent and the counter-advice from JLP.
I also think that mental fortitude is key, but that is built by education. I got the impression - although it’s just an impression - that Lila may have jumped into the market without much understanding of how it works in the first place. That creates nervousness, which leads to panicky exits from the market. I have not checked my retirement accounts or my brokerage for a couple of weeks now. I have a carefully-planned investment strategy and no intention to liquidate anything for at least another 20 years (when I retire at 55 *cross fingers*). I spent a lot of time planning and getting comfortable with my strategy, and fluctuations in the market - down OR up - are going to change it.
August 29th, 2007 at 5:30 am
[…] Keeping A Level Head In A Down Market: Should You Stay The Course? An excellent look at a disagreement between personal finance bloggers. (@ lazy man and money) […]
August 29th, 2007 at 4:03 pm
reacting to what the market is doing any given day or week is a testament to behavioral finance.
no one should be putting short term $ in the market as it is; it should be 5+ year $ only (as in, for goals that are 5 years+ out).
the effect of having only long term $ in the market is riding out the waves, resulting in a fair gain when the money is pulled for said goal(s).
August 31st, 2007 at 2:19 am
Star Money Articles for the Week of August 27…
Here are some recent interesting posts from the MoneyBlogNetwork and beyond: Five Cent Nickel discusses longevity insurance. Blueprint for Financial Prosperity gives details on Wilmington Trust Direct. Consumerism Commentary kicks off a series on renta…
September 1st, 2007 at 9:38 pm
[…] Lazy Man and Money writes on keeping a level head in a down market. […]
September 3rd, 2007 at 5:37 pm
[…] Lazy Man at Lazy Man and Money writes about keeping a level head in a down market and asks should you stay the course? […]
September 4th, 2007 at 7:06 am
[…] Man at Lazy Man and Money writes about keeping a level head in a down market and asks should you stay the course? I used to be afraid of risk but now I’m more afraid *not* to […]
September 7th, 2007 at 7:44 am
I think one answer is to be diversified across asset classes. Have some stocks, bonds, real estate, precious metals, and cash. Rebalance your asset allocation periodically to move money out of asset classes that have gotten ahead of themselves.