“THEN I LOGGED ON and saw all the balances showed red numbers!” my friend Hazel bemoaned as we walked around our neighborhood park.
Hazel had started investing only about six weeks prior to our conversation. Despite taking quite a bit of risk in her career, which paid off, she self-identified as a risk-averse person when it came to her money. Hazel rationally understood why she should have some of her money in the market, but battled knee-jerk reactions to take her money out when those obnoxious, red, downward-pointing arrows showed up next to her investments.
I knew all this, which is why I responded by saying, “I texted you not to check your investments today. We’re going through a market correction, so your investments were bound to take a tumble, but it’ll be okay.”
“Yeah, but I can’t log in to my bank account without also seeing my investments,” she shot back.
“Oh, yeah, that’s a bit problematic,” I acknowledged with a wry chuckle. “Are the investments at the top of the screen or the bottom when you log in?”
“Top,” she said.
“Okay, I know this sounds silly, but what if you just cover your investment information with a sheet of paper or your hand when you log in to do your regular banking? That way, you aren’t checking in on your investments, essentially against your will, on a weekly basis.”
The recommendation sounds silly, but sometimes we have to set up this kind of barrier to protect our portfolios from ourselves. Frankly, you can be the biggest danger to your portfolio, especially if you have a low tolerance for risk.
The biggest issue with investing for both novice and seasoned investors is handling their emotions during market fluctuations. It’s particularly difficult for risk-averse people to start investing at all and then leave well enough alone when the market starts to tumble. But it’s important you learn how to grab the bull by the horns and avoid letting the bear intimidate you. Stock market puns!
Remember in shows like Fear Factor how contestants underwent a perverse version of immersion therapy by completing awful tasks like being in a tank with snakes? While not as extreme, investing isn’t completely dissimilar. You have to face your fear of losing money.
“The bottom line is the stock market does go up and down. That’s just the nature of the stock market,” says Carrie Schwab-Pomerantz, president of Charles Schwab Foundation, and senior vice president of Charles Schwab & Co., Inc. “But over the long term, it outperforms bonds and cash.”
Of course, knowing this doesn’t exactly keep you from having an emotional reaction.
“It’s easy, when the markets are down, to get emotional about it and start pulling dollars out of the market when it’s going down and putting dollars back in the market as it’s rising,” says Julie Virta, senior financial advisor with Vanguard Personal Advisor Services®.
The particular problem for many Millennials is that we grew up during the Great Recession. Kelly Lannan, director at Fidelity Investments, graduated from college in 2008, directly into the market downturn. “It was very scary seeing that, so as a result, I think we’re naturally risk averse,” acknowledges Lannan. “I think that Millennials are good savers, however, making that transition from taking something in your bank account that you can see every day, that’s very safe, it’s federally protected, and then putting it into an investment vehicle where there’s much uncertainty, well, it can be hard to understand.”
While the Great Recession may have caused some of the anxiety, it also provided a valuable lesson.
“The market was at an all-time high in 2007. When I say ‘the market,’ I mean the S&P 500 as a benchmark,” says Schwab-Pomerantz. “Then, in 2008, it crashed 50 percent. So, if you had 1,000 bucks, all of a sudden it’s $500 if it’s in the S&P 500. But guess what? Not only has the stock market surpassed the 2008 number but also the 2007 number.”
This real-life example demonstrates the importance of a buy-and-hold, long-term strategy when it comes to your investments. Had you been invested in the S&P 500 in 2008 when it dropped, and then sold, you would’ve not only lost $500 by selling, but also lost out on the gains of the market that rebounded and surpassed a previous all-time high.
One of my professors liked to share a story about her neighbor. Her neighbor knew she worked in finance and liked to make small talk in the elevator by saying, “Guess how much I made on x, y, z stock yesterday?” My professor would always respond with the same line: “Oh, did you sell?”
The point of her story is that you haven’t actually made a profit until you sell your investment and the money becomes liquid. The same is true on the other side of that scenario, when the stock market is taking a tumble.
“Hopefully, you won’t panic and sell, because guess what? You’re going to lock in your losses,” says Schwab-Pomerantz.
This is why you’ll hear both in this book and from many other investors that the buy-and-hold strategy is important. You should be playing the long game here, so if your portfolio drops because the market is going through a correction, or worse, a recession, then you haven’t actually lost the money until you sell. And if you sell you have no opportunity to gain it back when the market goes back up.
It’s understandable if you feel like my friend Hazel. Investing in the stock market can be intimidating, not just because you don’t totally understand how it works (yet), but because you don’t want to lose money. That’s where two important investing strategies come into play.
I asked many experts which terms they thought every rookie investor should know, and almost every single one said asset allocation and diversification. The reason these two terms are so critical is because understanding them and, more important, putting them into play will help mitigate the risk you take by investing your money in the stock market.
It’s certainly not just rookies who use these strategies.
“[Asset allocation and diversification] are the investing strategies used by the largest pensions and funds in the United States,” says Schwab-Pomerantz. “This whole notion of a well-diversified portfolio and using proper asset allocation of stocks, bonds, and cash—that’s how the most successful investors have achieved their success.”
Diversification is pretty simple to understand. You don’t want to “put all your eggs in one basket.” You don’t want to invest in a single asset class—for example, don’t leave all your money in cash or just in stocks or exclusively in bonds or only own real estate. Then you want to also diversify within an asset class—for example, don’t invest only in a single company’s stock.
The use of asset allocation is twofold, according to Jill Schlesinger, CFP®, CBS News business analyst and author of The Dumb Things Smart People Do with Their Money. “Over the long term, what you’re hoping for is that different asset classes act in different ways over different periods of time. But, essentially, it’s like hoping to protect you from yourself, because if you have 100 percent of your money in stocks, and the stock market drops by 20 percent, your $1,000 is $800. That might freak someone out. But if the stock market goes down by 20 percent, and only half of your money is in stocks, then if your $1,000 went to $900, it may feel more bearable. So, asset allocation is something that can really help people. What it also does is limit your upside sometimes, when the market is running away, but you have to be willing to make that deal with the devil. I’m willing to forgo some of my upside because the downside scares the shit out of me.”
We all love a good rule of thumb, especially when venturing into a new endeavor like investing. It helps simplify a potentially challenging situation. The rules of thumb in investing are plentiful, but that doesn’t necessarily mean you should follow them.
A common one you’re likely to hear is that (100)–(your age) = the percentage of your portfolio that should be invested in stocks. In my case, that’s (100)–(29) = 71, so 71 percent of my portfolio should be invested in stocks.
But here’s the rub: that doesn’t account for my time horizon, goals, or risk tolerance.
“No, there is no rule of thumb,” says Schlesinger. “Everyone wants there to be a rule of thumb, so there are shortcuts, but I think it’s preposterous, in this day and age, that we’re looking for rules of thumb when doing a very quick questionnaire online or going through an app that will take all of two minutes; we’re still looking for shortcuts. The shortcut is that technology will do it for you.”
Many brokerage firms offer free tools online for both customers and non-customers. You usually have to answer about ten to fifteen questions, and up will pop a recommendation for asset allocation that will be far more specific than a general rule of thumb. These questionnaires will also force you to really think critically about your investing strategy.
I typed “asset allocation calculator” into Google and found Vanguard’s investor questionnaire in about fifteen seconds. The eleven-question questionnaire took me all of five minutes to complete and offered links to more information about what to know before reallocating and how my percentages compared to other allocation mixes.
Hazel had the misfortune of checking on her investments against her will simply because she needed to log in to her checking account. Checking on your investments frequently is not a good strategy for most people, regardless of their risk tolerance. “Don’t look at your portfolio every day or several times a day. It’s a long-term endeavor,” says Schwab-Pomerantz.
“Generally speaking, six to twelve months,” says Maria Bruno, CFP®, senior investment analyst at Vanguard Investment Strategy Group. “You don’t want to do it too frequently, because basically you’ll just [be] chasing your [own] tail—the markets do have bumps in the road and ups and downs.” She adds, “At a minimum, check once a year. And pick an anniversary date.”
Why do you need to even check in the first place if you have a buy-and-hold strategy, you may wonder? Because you’ll eventually need to rebalance your portfolio to ensure that your overall asset allocation continues to be aligned with your goals, time horizon, tax strategy, and risk tolerance. If you purchased stocks and bonds with a 60/40 split and then the stocks performed really well, you could suddenly be at a 70/30 split, so you’ll need to rebalance to get back to 60/40.
Ultimately, your biggest challenge is probably going to be learning how to put a line of defense in place so that you can protect yourself from yourself. Unfortunately, I don’t know your exact idiosyncrasies to help make that happen, but here are some suggestions that may help uncover what can work for you.
If you’re anything like my friend Hazel, then you may want to invest with an institution that’s separate from where you do your banking. Don’t subject yourself to seeing what your portfolio is doing each time you need to access your checking or savings account.
“Always knowing you have a nest egg in emergency reserve will keep you from raiding that money you have invested for the long term,” says Schlesinger. “Don’t confuse your short-term, intermediate-term, and long-term money.”
One of my favorite tactics is to nickname my savings accounts. Instead of seeing “Account no. 384841,” I will change it to something like “Honeymoon: South Africa, 2019.” Being specific reminds me why I’m saving and throws up a little psychological block in case I’m tempted to skim just a little off the top for an indulgence today.
Schlesinger recommends doing something similar when it comes to your investments. “If you keep those goals in mind and you say, ‘It’s in my retirement account,’ that can be a really helpful way to prevent you from doing something dumb.”
You may already have experience with automating contributions if you contribute to an employer-sponsored retirement plan. Setting up automation means one less thing on your to-do list each month, and it increases the likelihood that you’ll consistently be investing money. Most brokerage firms have an option for setting up automatic investing that will pull your monthly contribution out of your checking account and put it into your investments.
Automating also provides a way for you to buy in to the market at various prices, a strategy known as dollar-cost averaging. “Dollar-cost averaging allows you to buy low when the market goes down and, obviously, you also buy when it’s high, but you get a better price on average,” says Schwab-Pomerantz.
“The more you understand the market and the history of it, the more comfortable you’ll be,” says Schwab-Pomerantz. “Make an investing plan, stick with it, and try to avoid the noise. I remember 2008. It was such a scary time for all of us, even in the business, and I asked my advisor, ‘So, Mike, the phones must be ringing off the hook.’ And he said, ‘Actually, Carrie, no. Everybody has their plan. They know their risk tolerance, they’re well diversified, they know the market goes up and down, and they’re staying committed to their plan. There’s only one client who called, and he’s just a nervous Nelly who always finds an excuse to call.’ Having a plan and understanding it can help you ride out those ups and downs.”
We’ll discuss options for hiring help, but Schwab-Pomerantz recommends hiring a financial advisor if you need an accountability buddy or want the assistance. “I use a financial advisor. Even the pros get help,” she says.
“As humans there is greed and fear and following the herd. That’s not what investing is about,” says Schwab-Pomerantz. One of my favorite investing urban legends is that Joseph P. Kennedy Sr., father of John F. Kennedy Jr., famously sold his investments just days before Black Tuesday, when the stock market crashed in 1929. He claims that he knew it was time to get out because he’d received stock tips from his shoeshine boy. The line “When your shoeshine boy is giving you stock tips . . .” still gets used to this day.
There will always be the hot new stock or commodity everyone is talking about. From tulip bulbs to Beanie Babies to Bitcoin, it’s just a reality of investing. You need to be careful about staying true to your own goals and plan. Any dabbling in the latest hot tip needs to be done with the speculative part of your portfolio that you can afford to lose.
Despite all this advice on how to mitigate risk and protect your portfolio from your knee-jerk reactions, you may still be coming to the conclusion that investing is just 100 percent not for you. The idea of putting your money in any investment, no matter how conservative, sends chills up your spine and a pit of nausea floods your stomach.
“Know that if you can’t do it, it’s not the worst thing in the world. It’s just that you’ve got to save a lot more money,” says Schlesinger. “Your money, when you invest it, is doing some of the lifting for you. When you’re completely risk averse, it just means you’re going to have to save a lot more money to reach your goals.”
☐ Embrace the fact that the market will go up and down.
☐ Put an investing plan in place that aligns with your risk tolerance but also helps you meet your goals.
☐ Understand the importance of asset allocation and diversification in your portfolio.
☐ Set up barriers to protect you from yourself when the market takes a tumble.