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How to Undo Investment Paralysis

by Steve of Brip Blap on 03/26/08

Sometimes being too savvy about investing can paralyze your decision making. Back in December I had a feeling that the market was going in a bad direction, and I sold a fairly significant portion of the index funds in my IRA (about 25% of my overall holding). Yay! Right? I missed the horrible downturn, and while the remainder of my investment portfolio has taken a beating like Clint Eastwood in A Fistful of Dollars, I left this portion in a money market fund, chugging along at 3%.

The problem now is that I’m hesitant to start investing again. I shouldn’t be – even if we aren’t at the bottom, the chances are very good that if I go right back into the same types of investments I’ll be just fine. I’ve slightly altered my mix (going lighter on corporate bond index funds and beefing up my domestic positions) with recent contributions, but that cash is just sitting there mocking me. The monthly interest rolls in and I wonder whether I can time the bottom of the market.

When the market is this bad, my risk averse nature really kicks in. I am more anxious to avoid a loss than I am to take a chance on a gain. This thought pattern haunts a lot of people, and it does not serve me well. I have been somewhat successful at avoiding huge market downturns, but I’m usually late catching them on the upswing again.

So how do you avoid getting paralyzed by concerns about the weak economy and the struggling market? Here are a few ideas:

1. Don’t look year-to-date returns on mutual funds or stocks or any sort of investment. I understand why mutual funds try to rope investors in with their 5-year, 3-year, 3-month, year-to-date and so on returns – anybody likes looking at “15% returns” when they are investing. But it takes about two seconds for anyone to understand why this approach doesn’t work: for example, the Patriots won 16 games in the regular season, and their first two playoff games. Does it mean they were automatically guaranteed a 19th win? No. Past performance does not ever guarantee future results.

2. Diversify. With a good mix of index funds, you should be automatically diversified. Right? Wrong. If you have 100% of your investments in Vanguard mutual funds, you’re banking a lot on Vanguard, aren’t you? I am. It makes me nervous, and I plan to do something about it as I go back into the market – I’m going to try to find something besides the personal-finance-blogworld-beloved Vanguard to invest in. And as far as that goes, there’s a lot to be said for diversifying outside the stock market, too – real estate investing, P2P lending, investing in small businesses and even investing in yourself by continuing your education. Instead of investing only in the stock market, branch out. Now is as good a time as any to start a portfolio that isn’t restricted to equities. Diversifying your investments helps spread the risk and loosens that paralysis.

3. Be realistic about macroeconomic issues. I liquidated 25% of my holdings in December, and in retrospect, that seems about right. In terms of catastrophic market meltdowns, I think we are about at 1 star out of 4. I think the worst is behind us, because the root causes of a recession have already infected the economy like a virus. But much like a virus with a 14 day incubation period, once the symptoms start showing you are actually closer to the end of the sickness than the beginning. And people, let’s face it – although the market is down and homes are being foreclosed, the vast majority of Americans still have jobs, still buy stuff and still pay taxes. People will still need to borrow money, maybe more than ever. P2P lending should grow faster than ever while the banks are credit-shy after suffering quarter after quarter of writedowns. But the important thing to remember is that the engine of capitalism is not stopping, it’s just sputtering for a second. The next president needs to take it in for some routine maintenance and some tune-ups after the last eight years, but I think we’re a long way from needing to trade it in.

4. Don’t stay invested heavily in the US. I’ve seen this mentioned elsewhere, but keeping more than 50%-60% of your savings invested in the US is not wise. The US doesn’t represent 50% of the world’s capitalization, so it should represent that much of your portfolio if you want to be diversified. In the same way that smart people got in at the beginning of the dot-com and real-estate booms, there are a lot of markets around the world that are growing far faster than the US market. Failing to invest heavily in overseas markets is dangerous for anyone planning to retire 10+ years in the future.

5. Stick to a formula but don’t be inflexible. I have stuck to a 30/30/30/10 formula for a long time (US, international, bond and “other”). I’m changing it, but I’m going to stick to my new formula for a while. Now I’m going to switch to 40/30/20/10, because I want to cash in on the US market when it’s at a low point, and I am not comfortable about the prospects for the bond market. I feel the need to get more aggressive although I’m doing it within the confines of an index fund strategy. Bonds were not providing the normal “hedging” protection they’ve provided in the past, since the Fed keeps cutting rates every time they draw a breath these days.

So don’t let the gloom and doom stop you from investing. Shake it off and get back in there, champ.

Steve S. is the author of Brip Blap, a blog about personal finance, health, career management, productivity and self-improvement. He lives and works as a contract governance and audit consultant in the New York City area, and has lived in Germany and Russia. He is an active lender at Prosper.


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4 Responses


PrivateLender | March 26th, 2008 at 5:48 pm

This market’s irrational volatility is the investor’s best friend because it makes it easier to buy low and sell high (as explained in “The Intelligent Investor” by Benjamin Graham).


Mike | March 27th, 2008 at 11:42 am

You’re worried about Vanguard going under and the mutual funds being wiped out? Might I suggest that you should be putting your cash in gold, guns, canned food, and a bunker in Montana.


Four Pillars | April 14th, 2008 at 6:45 am

Good timing on your sell.

My suggestion is to read Four Pillars of Investing and convert yourself to a passive investor and you won’t have these issues (unless of course you can repeat the great market timing).

I disgree with your statement that having all your index funds with Vanguard is not enough diversification. Vanguard doesn’t “own” those assets and can’t (shouldn’t) be able to access them even if they wanted to commit fraud or they went under.

Your other suggestions are quite good. Changing your “investment plan” is ok as long as you have a good reason for it (which you do).

Mike

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