For many investors, these are disturbing times.
Last April, London’s FTSE 100 index reached an all-time high of 7,104. In the market turmoil of mid-January, it plummeted as low as 5,640 — a fall of over 20%, marking an official bear market.
So should you be worried? Many investors clearly are. And despite the market’s recovery over the last week or so, I for one wouldn’t be surprised if subsequent dips took us below even 5,640.
So let’s repeat that question: should you be worried?
The answer depends on a number of factors, including your individual circumstances and your future plans. If your pension is in funds and trackers, for instance, and you’re thinking of shortly retiring and buying an annuity, then that fall of 20% is very real. All things being equal, you’ll be buying 20% less annuity income than you’d have got last April.
But such examples are relatively rare. The vast majority of investors don’t have to face the prospect of imminently selling up, and so such temporary falls — and they will be temporary, albeit of an unknown duration — are simply business as usual. Markets go up, and markets go down.
Three Key Lessons
Even so, present market conditions underscore a number of important lessons for investors. Lessons that are easily overlooked — or wilfully ignored — when markets are riding high and life’s a party.
None of these lessons are new, of course. Many have long been enshrined in words of wisdom from investing legends such as Warren Buffett, Sir John Templeton, Howard Marks and so on.
And moreover, most of us have heard them many times. It’s just that when it’s our money that’s at stake, following someone else’s advice never seems quite as sensible as following our own wealth-preserving instincts.
Instincts that sadly, in many cases, can lead to wealth destruction rather than wealth-building.
So what are these lessons? Let’s take a look.
Invest For The Long Term
Here at The Motley Fool, we’re generally minded to be long-term buy-and-hold investors.
That’s because churning your investments saps your performance through trading costs, even if you can get in and out of a given position without incurring wealth-destroying capital loss.
It’s generally better, goes the logic, to take your time over the selection of a stock, pick a decent business run by skilled managers, and let them get on with the job of building your wealth.
It’s certainly a strategy that has worked well for Warren Buffett, of course.
“When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever,” he told investors in his 1988 letter to shareholders.
And nothing has changed since. Like Buffett, your invest horizon should ideally be decades — not days.
Buy When Markets Are Cheap
That doesn’t mean to say that you should ignore market volatility.
Not from the point of view of selling, but buying.
The best time to invest is “when there’s blood in the streets”, advised Sir John Templeton.
Warren Buffett says much the same thing, but adds a codicil about when not to invest: be greedy when others are fearful, and — importantly — be fearful when others are greedy.
In other words, try to buy when markets are depressed, and try to keep your hands firmly in your pockets when euphoria rules.
Again, it’s a long-term strategy. Because with a long-term investment horizon, you can afford to look on periods of volatility — or low prices — as opportunities, not threats.
Spread Your Risk
Let’s return for a moment to Warren Buffett’s remark about being fearful when others are greedy — in other words, being cautious about loading up on all the shares that others are piling into.
Yes, it’s Buffett telling us to be contrarian. But there’s also another lesson to be learned: the value of diversification.
Think back to the dotcom crash of 2000-2001, when investors loaded up on so-called New Economy stocks, paying ridiculous prices for ridiculous businesses.
Or the 2007-2008 ‘credit crunch’ and ensuing recession, when investors had loaded up on highly leveraged financial stocks with big exposures to dodgy mortgage debts.
Or, at the present time, the investors suffering because they piled into supposedly high-flying oil and mining stocks — some of which are now down 90%, or worse.
So spread your risks. A portfolio spread across multiple sectors will always be more resilient to adversity than a portfolio concentrated on just one or two sectors.
The Underlying Challenge
So there we have it: three common-sense ways to be a better investor.
Rocket science? No. But difficult, yes.
Because as Buffett has also sagely observed, one of the most difficult aspects of investing is controlling your emotions — and each of these three ways requires you to do just that.