So, you missed the big market rally. U.S. stocks have moved nearly 150 percent since the March 2009 lows, and you sat out most of those gains.
I’ve heard all the reasons: Maybe you jumped out of stocks in 2008 and stayed out. Perhaps you were in at the lows, but after the first 20 percent advance, you lost your nerve. The Flash Crash of May 2010 sent you running for cover? Or was it the 19 percent drop before QE2 was announced in August 2010?
There’s always some reason that looked good at the time. The asset management business, it turns out, involves a lot more behavioral counseling than you might guess. In any case, the markets have powered upward and onward without you.
What do you do now? How to begin to repair the damage?
It is a two-part process: The initial steps are designed to help you overcome your risk aversion — the emotional aspects of investing. Call it your “erroneous behavioral economic zone.” After we fix that big underutilized brain of yours, we can move on to the investment steps that allow you to work your way back into markets.
1 Acknowledge the error: First thing you need to do is own up to the mistake. No, this wasn’t the fault of the Fed or President Obama or some algorithm trading server somewhere in New Jersey. It is your portfolio, your retirement account, your future. You cannot fix it if you are still blaming everyone else. (I find that tracking my blunders in annual mea culpas to be helpful).
2 Stop beating yourself up: This market has confounded amateurs and pros alike. Unless you came to an early understanding of how the Fed has been driving liquidity and, therefore, equities, it was easy to miss. As we noted last month, even the supposed best and brightest hedge fund managers have stunk up the joint. Give yourself a break, and move on.
3 Change your sources: Most of the people I speak with who have missed this huge move have been consuming a diet of doom and gloom. If you think that it doesn’t affect you, you’re kidding yourself. Constantly reading about hyperinflation and the collapse of the dollar and the end of the United States as a world power and the student loan crisis and omigod Obamacare is going to crush America and the Chinese are taking over the world and . . . STOP! Right now.
It is recession porn, a focus on the negative that is a leftover effect of the crash and great recession.
Go through your bookmarks, and delete all of these sites: the goldbugs, the end-of-worlders, the doom-and-gloomers, the outraged Fed critics, the Obama haters. They all have agendas that typically have to do with selling you subscriptions or advertising. They are not at all concerned with your returns, your portfolio or your retirement.
4 Review your process: Now that you have eliminated the crazies, look at the rest of your process. How do you make investment decisions? Are you careening from stock pick to stock pick, after watching too much financial TV? Do you even have a process?
Whatever it is you have been doing obviously has not been working. It is likely you are missing two important components of an investment plan: the plan itself and an error-correction method that allows you to reverse the inevitable mistakes that will occur.
5 Create an asset-allocation model: Of course, if you missed the entire rally, you don’t have much of a plan. You need a full-blown investment strategy.
Own five to nine broad indexes, typically in exchange-traded funds (ETFs) or low-cost mutual funds. In decreasing amounts (35 percent, 30 percent, 20 percent, 5 percent), you should own: large caps, small caps, emerging markets, global equities, technology, real estate, bonds (corporates, Treasurys, munis) and commodity indices.
This is your asset allocation model. And here’s what to do with it:
6 Deploy your capital: You need to make your capital work for you, not sit in cash. Deploy this capital based on time, on market levels, on a model or any objective metric, just so long as it is not driven by your gut instinct.
When it comes to investing, your emotions will betray you every time, sending you running in the wrong direction and at the worst possible moment. Using a framework of entries that are objectively derived overcomes this risk-aversion problem.
7 Dollar-cost average: You can allow time to work in your favor by deploying your capital in 12 monthly (or four quarterly) equal amounts. This avoids the classic market timing issue, and allows any market volatility to work in your favor. The other advantage is that if the market runs away to the upside before you fully deploy, you at least have some exposure, and you are averaging up into the rally.
Historically, the math works better with lump-sum investing, but understand that this strategy is about emotions, not numbers.