In the book "The Psychology of Money," Morgan Housel lays out the bargain we make to become investors. "Successful investing demands a price. But its currency is not dollars and cents. It's volatility, fear, doubt, uncertainty, and regret -- all of which are easy to overlook until you're dealing with them in real time."
Over the last couple of months, you have probably given up more than just a return on your money. Like me, you have given up some emotional currency as you discover less money in your accounts than you had in January. This is part of the deal. But we need to be reminded occasionally exactly what the deal is, especially if we are on the brink of deviating from our long-term buy and hold strategy.
Let's take some sample conversations over the last few months from retirement plan participants.
The opening scene: "My statement says my money is down xyz dollars. I can't take it. Can I invest in something else?" Or "I am going to sell and wait for this to pass and then get back in and make more money." Or this statement coupled with a look of defeat: "I have lost so much money."
To the ones implying that they want to engage in market timing, who possibly have unique insight into what the market is going to do, I respond, "What makes you so sure that you know something millions of others can't possibly know?"
To the ones who are paralyzed with fear I suggest: "What did your money do last year? And the year before that and the year before that and the year before..." You catch my drift. They seem surprised when they learn that they have more money now than if they had been in cash this whole time, including the loss they see on their statement.
Let's identify the two distinct issues. The first is driven from overconfidence and a belief we do not have to pay our Housel toll; the second is our fear triggered by loss aversion and the inability to tolerate the emotional toll during downturns.
Can we really avoid the currency that Housel says is required to invest our money? Not likely. Let's walk through why.
If we are, indeed, right now in a recession of any kind, a light one or a deep one, should that change anything about our investing strategy?
The simple answer is no. The complex answer is very, very unlikely. On a particularly dark day in the stock market two months ago, a friend proudly texted me the news that he had gotten out of stocks and into cash back in January. (Translation, I saw this coming and sold perfectly at the top of the market.) I immediately imagined a scorecard out there. "Timing the stock market round one: One point."
But now, what does he do?
Assuming he did not buy back in on that dark day in June, does he get back in now, having missed a double-digit return? Or does he assume it will go back down, possibly dropping even further based on a new set of facts? Let's say he assumes the latter is going to happen. When exactly does he get back in? Exactly how much will the market need to fall before he thinks it's landed at the bottom?
So, is his financial risk that he prematurely buys back into the market and misses out buying at the bottom?
Sadly no. The risk is far more serious than that. The risk is that the market doesn't go down at all but rather goes up (however implausibly) and then exceeds the price it was in January when he got out. He could find himself in cash and miss out on the opportunity cost of his money growing. Does he find himself second-guessing every moment when he could still get back in, maybe hoping the market will have another correction that will give him a shot at buying lower?
I remember in 2008 when the financial world was truly terrifying. Banks were literally failing. People were walking away from their homes en masse, and we didn't see a floor for housing prices. The darkness seemed to compound in 2009 when, implausibly, the stock market started going up. And up. And up. And but for a few blips, like now, it never really looked back.
Very few could have timed that. The market turned around amidst the darkest of headlines and economic outlooks.
Housel reminds us that there have been 33 recessions since 1850. Let's say over the normal course of an adult life, we experience 10 of them, and in each one we think we can time when to buy or sell stocks. Imagine how good, or lucky, we would have to be to make 20 perfect decisions. That's right. 20 of them. You must be right when you get out and right when you get back in. Being right 19 times then wrong even 1 time, like in the extreme case of 2009, could result in ending up with a lot less money than you would have had if you had just stayed the course during all 10 recessions. Case in point, I know people who have been in cash since 2009. It is heartbreaking.
Now let's move to the other end of the spectrum where people are terrified as they see their losses on their quarterly statements. What's likely happening is in their brains is called loss aversion. This is a phenomenon so real that it has a psychological definition. If we quote Investopedia, it's "a phenomenon where a real or potential loss is perceived by individuals as psychologically or emotionally more severe than an equivalent gain."
Recently I have rescued folks ready to bail by making the following point. Let's say you saved a certain dollar amount every month over the past five years since September 1, 2017, and have kept it in cash or invested the same amount each month in the total U.S. stock market. At this moment in time, (as of Aug. 6), you would have 30% more money than you would have had staying in cash -- and folks, this includes not only the recent downturn, but also the economic downturn in 2020 during the global pandemic!
One antidote for loss aversion in the future is to take note of how you feel right now. Remember how hard it is to see your nest egg drop and how confusing it is when you don't know if your money will go back up in 6 months, in 2 years, or according to headlines, maybe ever?
These are your teachable moments, folks, and they will help you counteract your loss aversion. A good, honest memory of how difficult it was to stay the course amidst uncertainty could be a powerful deposit into the emotional currency demanded during future times like these.
For those with over-confidence, find humility. For those suffering from loss aversion, hang onto your strategy even if barely by the fingernails. Either way, learn along the way to protect your precious strategy from yourself.
What you realize when you stay the course through these downturns is that the stock market doesn't really care how smart or dumb an investor you perceive yourself to be. In the end, the market rewards those folks who deposit their savings month after month into their retirement accounts and who invest in the same average, boring way, through good times and bad.
Take Housel's advice for investment strategy. "A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy."
Be average, my friends. Just stay the course.
Sarah Catherine Gutierrez is founder, partner and CEO of Aptus Financial in Little Rock. She is also author of the book "But First, Save 10: The One Simple Money Move That Will Change Your Life," published by Et Alia Press. Contact her at sc@aptusfinancial.com.