Robin Powell – author, journalist, editor of the investing and personal finance blog, ‘The Evidence-Based Investor’
Warren Buffett is the master of the one-liner. His stock in trade is the pithy statement that encapsulates an important truth about the stock market or investing, or just life in general.
One of our favourites comes from his letter to shareholders of his company Berkshire Hathaway in 1986: “Be fearful when others are greedy, and greedy when others are fearful.”
Buffett knows better than anyone how stock markets can mess with our brains.
When markets soar, the reflexive nucleus accumbens fires up at the back of the brain’s frontal lobe, and we instinctively want to buy. When markets fall, the amygdala floods our bloodstream with corticosterone, fear kicks in, and we’re overwhelmed by the urge to sell.
But piling into the market once prices have already risen, or rushing for the exit once they’ve fallen, is usually a bad idea. Human beings, in other words, are hard-wired to make poor investment decisions. The rational strategy is to stick to the same strategy regardless of the market environment.
Simple but not easy
Of course, it’s simple advice, but not always easy to follow. Like now, for example. The most popular US stock index, the S&P 500, this year suffered its worst first half since 1970, and market volatility around the world has shown little sign of abating. Australia’s S&P/ASX200 index lost more than 8% of its value in June alone — its worst monthly performance since the start of the pandemic.
So what can you do to stay rational? How can you keep your head when so many seem to be losing theirs?
Well, if you haven’t yet done so, read our market volatility survival guide. In it we recommend tuning out the noise from the financial media; avoiding the temptation to time the market; staying diversified; and keeping your focus firmly fixed on your long-term goals.
You could also watch this short video on the importance of disregarding factors you have no control over. There’s no shame in feeling anxious about the impact of global events on your investments: it’s a perfectly natural human reaction. But it’s totally irrational to think that by ruminating on it or just by doing something, we will somehow make things better.
Try using fear to your advantage
If you’re still feeling worried, why not look at things from Warren Buffett’s point of view and try to use other people’s fear to your advantage?
Remember: stock prices reflect the very latest information and market sentiment. And, let’s face it, the news of late has been pretty bad: the continuing war in Ukraine, for example, concerns over fuel shortages, rising prices and hikes in interest rates. Right now, risks to the economy, and to equity prices, are all around. No wonder investors are fearful.
But risk works both ways. Nobody knows what the future holds. True, the bear market may still have some way to run. But, by the same token, the news could actually improve. If and when it eventually does, stock prices will start rising. Who knows? In a few years’ time, we may even look back at the summer of 2022 and see it as a buying opportunity.
Think about it: stocks are significantly cheaper now than they were at the start of the year. In other words, they’re “on sale”. You wouldn’t expect a stampede for the exits when everything goes on sale in a department store. Why should stock markets be any different?
Enjoy buying at discount prices
The investment author and blogger Jonathan Clements hit the nail on the head the other day when he wrote: “I take no pleasure in seeing my portfolio shrink, but I love buying stock index funds at discount prices.
“As stocks have tumbled, the yield to investors — in the form of stock buybacks and dividends — has climbed from under 3.5% to perhaps 4.2%.
“That higher yield suggests the intrinsic value of stocks is also now higher. On the other hand, intrinsic value may have fallen because investors are now discounting the cash kicked off by corporations at, say, 10% rather than 8%, reflecting today’s greater uncertainty.
“If intrinsic value has climbed, it means stocks are better value than six months ago. If the discount rate has increased, it means investors are now demanding a higher return as the price for holding stocks. So, which is it, better value or higher future returns? I have no clue — but I’m good with either.”
Markets reward disciplined investors
We strongly recommend, as we always do after steep market falls, that investors just keep calm and carry on. Don’t be tempted to tinker with your portfolio — and certainly don’t stop drip-feeding money into stocks on a regular basis.
In the long run, the financial markets have always rewarded disciplined investors with balanced, globally diversified portfolios who keep on buying when others are selling. There’s no reason to believe they won’t continue to do so in future.