- Investors need to be confident of their investment approach to respond wisely to market volatility.
- A sound, sensible and thoroughly tested investment strategy leads to confidence.
- Even a well-designed investment strategy can underperform expectations at times.
It may come as a surprise to learn that The Market Commentator is an amateur vintage-sports-car racer. When I first started racing competitively, a veteran driver advised me that I would not know what my car and I were capable of until I spun out. The purpose of this advice wasn’t to encourage reckless driving that could endanger myself and fellow racers. Rather, it was to remind me to learn the extent of my driving abilities and my car’s capabilities, so that I would not exceed them. Understanding those key points laid the foundation for my becoming a more confident, better driver.
Just as it is critical for me to be realistic about my driving skills, it is critical for an investor to know their tolerance for risk generally and market volatility in particular. Just as I could not win a race I didn’t finish, an investor will not achieve her investment goals if she abandons a sound investment approach prematurely.
There are a number of ways an investor can stay on track, even when the stock market takes a sharp turn:
- Know Your Investment Objectives. An amateur racer like me, who races for the pure fun of it, can (and should) be more cautious than a professional driver who is racing to put food on the table. Similarly, an investor who is already financially secure can afford a lower risk profile and a less-volatile investment approach. There is no prize money in amateur racing, and the return for taking unnecessary risk in the markets is just as lousy.
- Know Your Time Horizon. I’ve had my best results in endurance races because I recognize that I don’t have to push it to the limit on every lap when there are many laps to go. Rather, a consistent pace over a long race will typically beat a blistering pace that can’t be maintained. Likewise, if you plan to remain invested for a long time, there is no reason to resort to high risk behavior, such as market timing or stock picking in hope of making a quick buck.
- Educate Yourself. The more a driver knows about the track they are racing on and the car they are driving, the more likely they are to be successful. Similarly, investors who have put in the time needed to learn about the fundamental, academic principles that govern the stock market and the economy, or have been careful to select an advisor who has done so, are more likely to remain confident when other investors lose their nerve in a market or economic crisis.
- Prepare for the Unexpected. Race cars are subject to a technical inspection at each event and every race team has a checklist to prepare their car for the big day. Similarly, an investment strategy should be questioned, challenged and rigorously back-tested before it is used, and just as importantly, subject to ongoing reviews after it is implemented.
Of course, even the greatest driver can’t win every race. Likewise, no one investment strategy will produce stellar results in all market conditions. As Bernie Madoff’s clients found out, advisors who overpromise are not to be trusted.
Perfection doesn’t exist when in money management strategies, but a sound investment plan can go a long way in helping you stay focused on the big picture and look beyond the latest bump in the stock market. Vintage car racing, on the other hand… well, see for yourself HERE!
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