Odysseus’ Rule To Survive Stock Market Drops
“Stuff wax in your ears when we sail past this island,” said Odysseus to his ship’s crew. “Mythic creatures, called Sirens, sing seductive songs. No man can resist them. The songs make sailors steer their ships into the island’s rocks.
Odysseus’ crew obeyed and sailed past the island.
I’ve paraphrased Homer’s Odyssey. Homer wasn’t just one of the greatest storytellers of all time. He offered a nugget of wisdom that every investor should heed today.
The Sirens represent day-to-day, week-to-week, month-to-month and year-to-year stock market movements. The financial media then amplifies their call, using radio, television, magazines and the Internet.
Unfortunately, the messages they broadcast (especially when stocks are falling) cast investors onto rocks.
That’s why smart investors ignore the media and stock market moves. Smart investors build diversified portfolios of stock and bond market ETFs. If they have an income, they add money every month of every year. They don’t try to time their purchases. And they don’t try to time their sales.
Unfortunately, many people think this sounds naïve. Too many of us think we can time the market, or find someone who can. When markets fall, news networks interview stone-faced blokes who claim to see the future. But it’s best to ignore them too.
There’s a saying that makes me chuckle. But it’s true: Economists have predicted 100 of the last 3 market crashes. No matter what year it is, there’s always a talking head on television saying stocks will crater now. This causes many people to jump out of stocks. It causes people to say, “I’m going to buy next month or next year, when the [insert your global drama here] has settled.”
But investors shouldn’t speculate. If you have a job, add to a diversified portfolio of ETFs every month of every year. When the markets fall, keep calm and carry on.
“What about those economists?” Can’t they predict the future, helping you to sell (or stopping you from buying) before stocks fall hard?”
I’m glad you asked.
Warren Buffett says, “Stock market forecasters exist to make fortune tellers look good.” Studies prove he’s right. Between 2005 and 2012, CXO Advisory tracked 6,582 stock market predictions by leading economists and stock market experts.
When asked, “Will U.S. stocks rise this year?” these experts were right just 46 percent of the time. Let’s put that in perspective. If someone had asked a five-year old the same question, and if the child said, “yes” every time, she would have beaten the economists. Between 2005 and 2012, she would have been right 85 percent of the time.
Historically, stocks rise during about 66 percent of calendar years. That’s an average of two out of every three years. However, that doesn’t mean there’s a pattern. We might think we can tell the market’s direction based on what stocks did last week, or based an economic indicator. But Warren Buffett says we can’t. And the evidence says he’s right. Experts can’t predict the market’s performance based on GDP, recessions, viruses, or unemployment figures.
Still, plenty of people listen to predictions. They listen to their guts. Many of them know they shouldn’t try to time the market. But they hear the Sirens sing:
The Sirens drive speculation, which hits investors in their wallets.
Over the ten-year period ending December 31, 2013, U.S. stock market funds averaged 7.3 percent per year, after fees. But according to Morningstar’s Mind The Gap Analysis, the typical investor in U.S. funds averaged just 4.81 percent over the same ten years. If people were rational, that wouldn’t have happened. If America’s mutual funds averaged 7.3 percent after fees, investors in those funds should have earned the same returns. But they didn’t. Instead they heard the Sirens sing:
Try to imagine this.
In 2003, Saddam Hussein had nuclear weapons. At least, that’s what many people thought. And he was crazy enough to use them (don’t laugh, the world saw him as a global threat).
That year, the U.S. invaded Iraq.
At the same time, investors still coughed on the smoke of the dot.com crash when technology stocks fell 90 percent or more.
The S&P 500 had fallen hard, three years in a row. It fell 10.14 percent in 2000. Stocks fell a further 13.04 percent in 2001. In 2002, stocks dropped another 23.3 percent.
Can you imagine the Sirens singing?
Between 2003 and 2013, stocks swung wildly. Experts on television called for financial Armageddon, after the markets fell in 2008. Most people listened to the Sirens. That’s why American mutual fund investors averaged just 4.81 percent per year, while their funds (after fees!) averaged 7.3 percent per year. People tried to time the markets. Too many investors said the same things:
“I’ll invest next year or next month, when things settle down.”
“I’m going to sell some of my investments because I heard stocks will crash. Then I’ll get back in later.”
“Stocks have a fallen a lot. Before investing, I’m going to wait until they fall further.”
Smart investors don’t try to game the markets. They don’t listen to forecasts. They don’t listen to their guts. They maintain diversified portfolios of stock and bond market ETFs.
A lucky investor might set their money on autopilot… and then fall off a bike…where they develop a selective case of stock market amnesia that lasts until their retirement. If that sounds crazy, please read on:
Business Insider’s Myles Udland conducted an interview with James O'Shaughnessy, who was the head of a U.S. investment firm. O’Shaughnessy had recently hired a former employee at Fidelity, one of the world’s biggest mutual fund companies. The employee said the mutual fund giant conducted a study to determine its best investors. Were they young investors? Were they old? Were they followers of investment news? Instead, the firm’s best investors were people who forgot they had an account with Fidelity.
Smart investing is simple. Invest when you have the money. Don’t speculate. Never let the Sirens have their way. Put wax in your ears if you must.
At times, the seas will be rough. The Sirens will sing and your strength will be tested. But if you stay consistent, you’ll sail into retirement and not upon the rocks.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.