With the current bloodbath in the market, many are fearful and some resort to panic-sell.
Here are some reflections I have during this volatile period.
I. Logic over emotions
Use logic, rather than emotions to guide your investment decisions.
Ask yourself, even as the market and economy changes, has the underlying business changed?
If the answer is no, you should love these stocks more when they are at a discount.
“Buy when there’s blood in the streets, even if the blood is your own.“
Volatility is a test of our temperament.
II. Don’t dig a deeper hole to make up for losses
We all hate the idea of selling an investment at a loss.
Psychologically, we experience twice as much pain from a single loss than a single gain.
Our human nature of being risk-averse can be harmful in investing.
This causes us to do two things.
Firstly, we hold on to losers in our portfolio, because we believe that these stocks will rise again.
And sell off winners too early to lock in the profits, because we worry that they will decline.
This is known as the “disposition effect” in behavioural finance.
Often, we would be better doing the exact opposite. Yes, the opposite.
Sell off the poorly performing stocks. Bite the loss early.
Hold on to the stocks that are rising because they are better positioned in the current environment.
*This comes with a few important caveats:
1. The Losers: The reason for poor performance is because of poor company fundamentals, deteriorating moat and margins.
2. The Winners: The good performance is due to having sustainable and long-term growth.
III. Stomach, Not the Brain
Growth stocks are being punished heavily in this current market condition.
Inflation is a worry for the stock prices of fast-growing companies.
Higher inflation will eventually mean higher interest rates, and thus higher discount rates for future cash flows.
Meanwhile, higher inflation and interest rates favours value stocks and cyclical.
This drawdown highlights the importance of having a diversified portfolio and one that is suitable for your risk appetite.
As Peter Lynch says, the key organ in investing is the stomach, not the brain.
“I’ve always said, the key organ here isn’t the brain, it’s the stomach. When things start to decline – there are bad headlines in the papers and on television – will you have the stomach for the market volatility and the broad-based pessimism that tends to come with it?” – Peter Lynch
IV. Shut up and Wait
When we are in the troughs of the market, it feels like this drawdown will go on forever.
It helps to take a step back and zoom out.
When we look at the big picture, at what happens historically, this will just be a blip.
Inaction is action. Investing is a marathon, not a sprint.