Stomach of Steel

A few weeks ago, when the US markets started dropping dramatically, a reporter for The Wall Street Journal called. He asked me if I had received any calls from worried clients. I told him I had heard from 5% of my clients. "What changes in their portfolios are you making?" he asked.

"I’m not making any changes to my investment strategy."


He expressed amazement that I was not "doing something." Most investors and their advisors he was speaking with were making "adjustments" to their portfolios. He told me I must have a "stomach of steel."

Hardly. My gut is certainly not immune to those fearful sinking feelings that go along with market plunges. What I do have is enough experience to trust my long-term investment strategy.

The time most investors and advisors decide an investment strategy doesn’t work is when their portfolios lose value, usually due to a decline in US stocks. This confuses me. Here's why:

First, I'm confused that so many investors believe it's possible to move in and out of markets in such a way that their portfolios will rarely, if ever, suffer a negative return.

This is magical or delusional thinking.


The only investor I’m aware of who consistently produced positive returns, year after year, was a fellow by the name of Bernie Madoff. If you have never heard of this investment wizard, he's the one who is now serving a life sentence in a federal prison for propagating a Ponzi scheme that robbed billions of dollars from investors.

Short-term or moderate-term losses are inevitable in any portfolio that seeks to earn returns above those offered by a bank Certificate of Deposit. Usually, in the long run, markets recover and so does your portfolio.

Sadly, too many investors turn short-term losses into long-term losses by abandoning their investment strategy when the US markets turn down. This locks in their losses, never to be recovered.

If your portfolio is widely diversified among many markets—like bonds, emerging markets, commodities, real estate, TIPs, and various investment strategies—you will almost always have an asset class losing money. You will also almost always have an asset class making money. If not, you probably don’t have a diversified portfolio.

Here's the second reason I'm confused.


Most investment strategies assume that the US market will decline, and they have a strategy in place for dealing with those declines. For a buy-and-hold investor, the strategy is to do absolutely nothing. For a strategic asset allocator like myself, it’s to rebalance frequently by selling appreciating asset classes and buying into those in decline. By not making changes to clients' portfolios during a market decline, I am not "doing nothing;" I am simply continuing to follow an investment strategy.

Because most of my clients have learned over time to trust this strategy, relatively few of them make panicky calls to my office during downturns. Yet I have noticed a direct correlation between US stock market declines and my daily phone call volume. Many of the calls are from reporters wanting to know what I am doing and am telling clients. My response—that I'm not doing anything different—is the same thing I told them when the markets last declined in 2011 and before that in 2009, 2008, 2002, 2001, 2000, 1997, etc.

This isn’t the response an anxious client or a concerned reporter wants to hear. When the emotional center of the brain is overcome with panic and fear, taking action helps relieve anxiety. If that short-term action is selling into volatile stock markets, however, it often turns out to be a long-term mistake.