Against the backdrop of an escalation of words between North Korea and President Trump, investors are scrambling to figure out what this means for their portfolios.
Should I hedge my portfolio by buying gold? Should I sell stocks?
My response: Do nothing.
Weeks like this are the perfect example of why you need a solid plan. Sticking to a plan, however, is not that easy. You need to be self-aware and accountable for it to work. Behavioral finance teaches us about loss aversion, which basically says that investors hate losses much more than they love gains. A 1979 study by Kahneman and Tversky found that a loss has about 2 times the impact of a gain of the same magnitude. It’s easy to say "if the market pulls back -10% I would invest more in the market." But then the news of North Korea’s escalation comes out and the questions we receive are "the market is down -0.5% because of North Korea, should I sell some stocks or buy gold?"
The reality is that when the market gives you a 10% or 15% or 20% correction, most people will just freeze or panic sell. Mike Tyson can describe this phenomenon in a much cooler way than I can. When describing an opponent he said,
"They were talking about his style. 'He's going to give you a lot of lateral movement. He's going to move, he's going to dance. He's going to do this, do that.' I said, "Everybody has a plan until they get hit. Then...they stop in fear and freeze."
So a flimsy plan alone won't work... it just won't. So what IS the right strategy?
We at Zoe believe that there are a couple of rules that you must set before you EVER make any important investment decisions.
1) Understand why you are investing.
What is your goal? Is it to buy a house? Is it to invest towards your kids college? Is it to invest towards retirement? Is it for fun? Nothing wrong with investing a little bit of money for fun, I enjoy playing Blackjack once in awhile knowing that it won't put my kids through college.
2) Understand that time horizons matter.
Always always, assume that your timing when you buy or sell something is not going to be ideal (because it never quite feels ideal). If you are planning to use your savings in a year to buy a house, investing your savings in bitcoin might not be wise, since you have no control of what the market will deliver you in the next 12 months.
3) Understand your risk tolerance.
It is easy to say "I am going to invest for the long run." Then you wake up one morning to find out that your 401k or brokerage account is down -12% in the last month and you freak out! Try to figure out how comfortable you would be with a -5%, -10%, -15%, -20% over the next 6 months. If you think you’ll scream uncle at -10% that matters. Because eventually, stocks WILL punch you in the mouth and deliver that -10% drop… is just a matter of time. The more you understand that and how comfortable you feel about it, the better chance you will have of not letting your emotions take over.
To calculate your risk tolerance now, click here.
4) Formulate an investment plan of attack that you revisit regularly.
Put it down in writing and tell your spouse or someone else about it so you feel a sense of accountability. Something like "Based on my risk tolerance and my medium and long term goals, I want to be invested 80% in stocks, 15% in bonds and have 5% in cash knowing that this portfolio will generate somewhere around 4 - 7% returns per year for the next decade.*"
Once you have the above in place you implement it yourself, you hire a robo-advisor or you hire a financial planner via Zoe ;) and you reevaluate numbers 1-3 from the list above, every 6 months to a year.
You may have noticed, North Korea didn't come up once in any of the above rules. You know why? Because you have no clue what Donald Trump is going to tweet next and you definitely cannot control or predict how the markets are going to react to any of this mess.
It's great to have a plan, but the market does not give a #@#@ about your plan. So that 80/15/5 initial portfolio from a few years back is now 90/8/2 after a huge stock bull market the last few years. In other words, the market has forced your portfolio out of line. So what do you do? You reevaluate your original goals every year and if they still are the same as before then you bring your portfolio back to the original allocation of 80/15/5. No emotion involved, no research necessary on what Kim Jong-un ate for breakfast this morning.
It's not easy to stay disciplined in this approach on your own when you have a day job, a spouse and kids, which is why we launched Zoe. But even if you do decide to go it alone, do not make investment decisions because of North Korea or the Republican or Democratic party headlines. You can't control any of it and whoever tells you they have an "edge" on any of these headlines is either 1) ignorant about how hard it is to actually have an "edge" 2) trying to sell you something or 3) Ray Dalio… who won't manage your money.
About the author: Andres Garcia, CEO and Founder of Zoe Financial, Inc.
*This is purely for illustration purposes. Do not make investment decisions based on this example.