The Biggest Investor Fear and How to Meet It

Most of those in the baby boomer generation are scared silly.  They are worried about retirement -- even poverty.  In the best case many now expect to work much longer before retirement.

Investment mistakes have been part of their problem.  If they make more mistakes, there will be no solution.

In this article I will provide an outline of the thought process required to be a successful individual investor.  Then I will suggest some ideas about how this applies right now.

The Background

Suppose you are an average person, looking toward retirement, with more than a few years in your investment time horizon.  You are intelligent and capable.  You make decisions with confidence, and without emotion.

If you have these attributes, this article is for you.  If you don't have them, this article is really for you.

Characteristics of the successful investor

This is a very brief outline of what you need to succeed.  Each step is essential.  This is not graded on the curve!

• Understand the need to plan.  If you do not have one, you are completely adrift and will almost certainly fail.
• Know how to plan and how to evaluate the outcome.  If your plan does not include adequate return or protection against inflation, you cannot expect to meet your retirement goals.
• Choose investment approaches that will meet your goals -- both risk and reward.  Don't kid yourself!  Do not pretend about risk tolerance.  Know the expected volatility of your investments.
• Understand your time frame.  The best way to meet long-term goals is through long-term investments.  This does not mean "buy and hold."  Active management requires finding good themes, weeding out losers, and rebalancing your portfolio.
• Adopt a system.  Discover a method for selecting stocks or ETFs that you know and understand.  Find a way to test or to verify the results.  If you do not have confidence in the system, you will abandon it at the worst possible time.
• Find warning indicators.  You need to know if something really unusual is happening.  Some said that 2008 was like a 100-year flood.  That might be an overstatement, but you want to have an objective indicator of that kind of problem.
• Stick to your system.  If everything is within normal ranges, then there is no reason for alarm.
• Beware of the news.  The news is always about problems and potential disasters.  Some of it comes from those profiting from your fear.  Widely publicized worries are reflected in market prices.  It is the unexpected --the true black swan -- that requires attention.
• Do not use political opinions in your investing.  We are in a state of perpetual campaigning.  There is always something wrong and we can count on the party out of power to make it all seem terrible.

And finally, if you have done all of these things right:

Give your plan a chance to work.

At times like now, many investors are wondering why they are not traders.  Someone -- their neighbor at a cocktail party perhaps -- sold at the very top.  The neighbor might do better, assuming that she buys back in.  You have many neighbors and the successful ones will always have a story to tell.

My experience is that trying to mix the trader and investor approaches does not work.  If you want to do this, you should allocate part of your account to each method.  The problem is that the rules and the psychology are completely different.  The trader does not -- must not --- care about fundamental values.  His time frame is too short, and his daily stakes are too high.

The other key is that the investor buys stocks that are hated by the market, especially by traders.

Wise Advice

Contrast the trader mentality with the advice of our generation's best investor, Warren Buffett, who was asked how an investor could be sure that an undervalued stock would eventually rise:

When I worked for Graham-Newman, I asked Ben Graham, who then was my boss, about that.  He just shrugged and replied that the market always eventually does.  He was right:  in the short run, (the market is) a voting machine; in the long run, it's a weighing machine.

and similarly:

For some reason, people take their cues from price action rather than from values.  What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else.  The dumbest reason in the world to buy a stock is because it is going up.

Many successful trend-following traders, including our Felix model, would disagree with that last statement, but it does highlight the difference between two perspectives - both of which are successful.

The investor should emphasize the value of the business, not worrying too much about the value on his statements.  One a year or so is often enough.  It is a different mentality.

The Current Prospects

In my weekly column on "the week ahead" I take a short-term focus, but also highlight factors of more general concern.  The trader approach has now been bearish for a few weeks.  This reflects market sentiment and trends.   Despite this, for long-term investors the current environment represents an exceptionally attractive opportunity.  The highlight factor is the widespread misperception about the misnomered "end" QE II, which will soon be known as the Y2K non-event of this decade.

In the last decade we saw an exception to progress.  The decade started at a time when demand and sales had been pulled forward.  Everyone worried about Y2K bought new computers instead of fixing software.  It was an unprecedented and exceptional boom, augmented by Internet fever.  The decade ended with a financial crisis  -- also of unprecedented proportions.  Taking this time period is starting with an atypical peak and going to an atypical trough.

Those who choose to take the last market decade and use it to predict the next, do not understand anything about history, progress, statistics, or causal inference.

For the fearful investor, your choice is clear.  You can be a deer in the headlights, mesmerized by fear, and watching inflation eat away at your remaining assets.  That is the slow road to realizing your fears.

Or you can take control.....

There are many, many stocks trading at dirt cheap PE ratios.  If you read widely, you already know this.  My very wise SA editor (who never takes any credit) encourages me to include stock ideas, so here are a few prominent ones, hated by traders and trashed in news stories.  That is good news for the long-term contrarian investor.

I have recently mentioned JP Morgan Chase (JPM) and Oracle (ORCL).   Even some noted market skeptics have recently opined in favor of Goldman Sachs (GS) and Microsoft (MSFT).  My list of qualifying stocks is much longer -- companies that have had great earnings and confirmed strong outlooks.

[I'll share some links on these points and a few ideas in upcoming articles in this series.  Most of the topics are familiar to readers of "A Dash" but the team will help me with some citations.  I hope this is a good start.]

 

Comments

[Danielle Taylor]

I think the important thing to remember is that these tips are for someone with a few years to go before retirement. If I was Jeff and was planning on retiring right now, I might be a little more worried about the market too.

Danielle
Online Stock Trading for Beginners

[oldprof]

James -- Markets thrive on a well-documented list of worries. I don't see anything on the list that makes this point in history worse than most others -- and I think that we have much to celebrate.

I recommend this piece: http://oldprof.typepad.com/a_dash_of_insight/2006/07/discounting_and.html

Or enter "wall of worry" or "worries" in the search box.

One reason I introduced the SLFSI to my weekly review was to add some objectivity to the process of evaluating risk. It is better than the newspaper!

Meanwhile, if you are in wealth preservation mode, I congratulate you and urge caution. For most of us who still need to create wealth, stocks are part of the picture. There are very few people for whom the correct stock allocation is "zero" yet many make that choice.

Best of luck with your decisions:)

Jeff

[James G. Vanasek]

Jeff,
While I appreciate your calm fact driven approach to the market fundamentals and not the noise, there are reasons for great concern. This slow growth environment will not produce adequate returns. Europe and Japan are in deep trouble and the recent articles posted regarding Portugal and Spain as the really dangerous issues in Europe, not Greece, are worth of concern. There will come a point where German tax payers will revolt. Japan was in trouble before the quake and now is in a much more difficult position. China also has public unrest, the biggest single concern of the current leadership. So while I hope you are correct there a many uncertainties and the US debt position could hit a tipping point at any time. Where to invest for retirement? Please tell me but I do not see it in this market.

[inkerton]

In my perception, you are more clearly distinguishing between investing and trading on this blog than you used to do, and you are more clearly highlighting the time-frame(s) (usually short) that you are modeling when you make your projections. If that is unfair, I apologize. But in any event, I appreciate it.

[Andrew H]

A refreshing back to basics reminder. Despite the soundness of the advice it is tough to shut out the noise. I am sitting on my hands at present watching valuations staircase downwards and trying to hold my nerve. I am not sure whether this advice takes into account views on currency exposure in the portfolio. US$ is not my base currency but I have $$ assets and it just adds an extra dimension of complexity. Whither the dollar??? Still, a good article, balanced as ever.