One bias we are all prone to is recency bias – a situation where we think (feel, really) that things will pretty much be the same and there will be no shocks or unwelcome surprises.
But markets aren’t known as the Great Humiliator for nothing.
It’s usually when we least expect it that markets rise or fall steeply on unexpected news.
Markets are traditionally forward-looking, and if we generally think the future is rosy there’s no reason to adjust our allocation or views.
The problem, as we also remind people, is that it’s the truck you don’t see that runs you over.
We’ve said for some time that we didn’t know what the exact issue would be, but given our experience in market cycles and our use of macro valuation tools such as the CAPE ratio, we said that markets were far too expensive and would most likely plunge at some stage.
And indeed they have.
We don’t take any joy in this, but simply point out that you need to incorporate a view of the future which canvasses as many realistic scenarios as possible.
As we’ve also pointed out when the markets collapse like they have, then cash, which we’ve been holding for some time, suddenly becomes extremely valuable.
A dollar, which a few months ago would buy, say, one share of a company, can now buy perhaps one-and-a-half…and in many cases, two.
This where you get to add value, so to speak.
A bit of patience and looking ‘wrong’ for 12 months while markets climb is all part of the cycle.
8 timeless principles
And so we refer at these times to our 8 timeless principles.
When markets do what they do, we understand that you need to have a systematic approach, meaning one based on a sensible set of rules that you always adhere to .
We often get tempted to let winning stocks run, even though a logical and prudent approach would be to recognise that real risks have risen, and potential rewards have fallen.
That leads us to understand how important market cycles are, and since we’ve been in the rampant speculation phase of the cycle for some time, we’ve been holding plenty of cash.
We still are.
And by plenty we mean a greater than 50% allocation to cash.
We realise the importance of the CAPE ratio and other macro valuation tools in giving us some valuable information about where we are in the cycle, and how we should be positioning ourselves for the future.
It’s important that you try to be one step ahead not one step behind.
It’s when markets crash (or rise exponentially) that an understanding of our own personality becomes so important, as the markets swing from greed to fear in an instant.
And along with that, our emotions change, we become much more conservative, and we may even impact other areas of our lives as we realise we should’ve been selling when others were buying.
We see risk where others focus on rewards.
We use our risk hierarchy principle to determine whether the level of funds we should have in the market and where they should be.
In the 4 action principles, we see the importance of asset allocation both at a macro level in determining the division between stocks, bonds, property, and cash…and at the micro level in terms of how much each investment or stock should be, and how much cash to hold against it.
We see the benefits of diversification, knowing that while there are cheap markets they may still become cheaper, making them even more attractive than they were previously.
Having a systematic approach with a developed investment plan allows us to methodically buy low and sell high at the times when others are doing the opposite.
And, of course, throughout the market cycle we ensure that we avoid being too greedy or too fearful by maintaining our rebalancing strategy.
The 3 Cs: cost, choice, and control
We often say that these principles aren’t perfect.
But over an investing lifetime, for folks who want to take control and manage their own money – what we call the ‘3 Cs’ of cost, choice, and control – these principles are a simple and effective roadmap for building wealth in whichever markets you choose to operate in.
It’s times like now when these principles become invaluable.
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