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.