Stock Market Correction? A Peek Into My Investing Philosophy.

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Apparently the S&P 500 dropped 3.5% yesterday. Not bad for one day!

Let’s see what I haven’t done yet:

1. I haven’t logged into, where all my IRAs are.
2. I haven’t logged into, where my 401(k) is.
3. I haven’t logged into Scottrade, where… oh wait, I don’t have any individual stocks right now.

Why don’t I care? Because not only do I not have any control over the numbers, but there is also nothing I am going to do in response to what I see. I won’t be relieved, nor will I get depressed.

Remember, for every trade there is a buyer and a seller. The buyer thinks he’s getting a good deal. The seller think she’s getting a good deal. Both can’t be right. So now you must ask, how much do you want to bet that you are smarter then the next person? Many of us are competitive people, and it’s hard to admit that you’re average. This pervasive human tendency to overestimate one?s achievements and capabilities in relation to others is sometimes referred to as the Lake Wobegon effect (where all the children are above average).

For example, do you think you are an above-average driver? During one such survey, 80% of respondents rated themselves in the top 30% of all drivers. Hmm…

On top of that, you are going against the headwind of trade commissions, the bid-ask spread, and taxes on generated capital gains.

By essentially investing in every publicly-traded company out there (although not on a perfect market-cap weighted basis), I am able to take a different, non-competitive view of things. The way I see it, every single day millions of people are waking up and going to work in order to create value. They are thinking up new ideas, making better widgets and services, and selling those widgets and services to new people. And then they go to sleep, and people on the other side of the world wake up and do the same thing. It doesn’t matter if they are working for Ford or GM, Intel or AMD, Sirius or XM Radio. As a whole, value will be created using my money, and I sleep well at night.

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  1. “During one such survey, 80% of respondents rated themselves in the top 30% of all drivers”

    This still can be a true statement.

  2. I knew about the Lake Wobegon effect but didn’t know it had a title. Interesting!

  3. I took the correction in stride too…checked my Roth and saw it was down 5%. A couple years ago I would have freaked out, but I’ve become more relaxed about it now. What goes up comes down and vise versa…

  4. Jonathan – that is definitely some of the most sane advice I’ve heard in a while 🙂 I’ll admit that I did take a peak at my 401k out of curiousity, but thanks for the reminder that we all in it for the long haul(or at least *should* be).

  5. I was a disciplined long term investor until yesterday! Like a car accident on the side of the road I had to look… Given that my portfolio’s beta is about 1, I shouldn’t have been too surprised to see my losses match that of the S&P500. Still I want my $6976 back! : )

    I’ve provided more details about it here:

  6. Very well said Jonathan! One of your best posts yet.

  7. I might sell if there is a large enough drop I can do some tax harvesting and offset some capital gains I had when I dumped a bunch of balance funds. Otherwise no.

  8. Brilliant writeup (definately “above average!”) – exactly my thoughts and exactly why i’ve been following your insight for the past 2 years.

    I’m the same age and started at the same net worth when I started reading your blog and have progressed simmilarly as you (though more agressively through additional investment in stocks). I’m glad you’ve updated your daily posting to include more of your investment thoughts now that you have the extra investment capital rather than sticking to only the penny pinching posts that have made me stop following other blogs.

    We are all on the road to a higher net worth road (and more valuable visitor eyeballs to advertisers for you :)) and postings like these help all your readers.

  9. goldnsilver says

    That’s exactly what I did, too. Which it’s nothing. I didn’t log into any of my account to see my balance.

  10. I have to admit, I did log in to my mutual fund yesterday. I wanted to know what my balance was (as of the day before, of course). I figured my personal ‘losses’ yesterday were about $1000. I literally laughed it off. Why? Those aren’t really loses until you realize them. I love having a long time horizon.

  11. I didn’t log into any of my accounts …

    … because I wrote my own portfolio tracker webtool that shows the changes in value of unified assets in realtime. But no temptation to sell. 3.5% was not even my gains the entire year. And I have > decade of gains to so we’ll need an dinosaur killing asteroid smacking the earth for me to go into the red.

    Wanted to buy though. My brokerages accounts are being transferred to Wells Fargo so my funds aren’t available yet. Otherwise, I would have bought some China ETFs to take advantage of the big drops. And I see they’re up 4% already today. 🙁

  12. I’d be hard pressed to rate myself as a driver.

    I’d rate myself down because I:
    –Have crappy reflexes
    –Don’t have the *right* reflexes in an emergency (steer into direction of skid, etc.)
    –Am too often distracted (coffee spill, etc.)
    However, I *know* that, so I:
    –Obsessively follow traffic laws (speed limits, turn signals, etc.)
    –Leave extra space around myself (following distance, swerve areas, etc.)

    I suppose the financial parallel would be that I:
    –Know I don’t have any particularly useful insider knowledge
    –Don’t have the time or energy to monitor/research stocks (all the time – I can and do for short periods)
    so I:
    –Invest in low-overhead index funds (and a few TIPS) and ignore the market

  13. All of the “me too” responses makes one thing clear. This hasn’t really been a correction. I’m generally a bull, and I am cautiously optimistic to the future while keeping in mind demographics. One of the most troubling things I see is, “Everyone knows that stocks are the best place for your money for the long haul.” The trouble is that the market is tenacious about allowing for the things that everyone knows.

    When we give back all of our YTD earnings big or end the quarter noticeably down (or the year) maybe we should call that a correction. I don’t think it counts until some attitudes are shaken.

  14. I totally agree. But I have to admit I was eagerly waiting to hear what the final damage to my portfolio would be. I didn’t and don’t plan on making any changes to my investments but I can’t help but knowing what happens 🙂

    I’m curious what you think of quant funds. I’m not sure it’s fair to put them in the same category as actively managed funds because they attempt to invest by modeling the market with statistical models. It’s a much less emotional away to invest without investing in the whole market. Some quants have done extremely well in the last 10 years. Like Bridgeway Funds for example, they have consistently good returns. Do you think that this is just a temporary out performance and that the funds will eventually revert to the overall markets performance or less? Or could quant investing be a viable way to outperform the market by quantitavely removing companies that don’t have the numbers to justify invetsment?

    Look forward to hearing your thoughts!

  15. I totally agree with you Jon. I haven’t even checked and barely heard about the stock market situation. Long term investing definitely has its perks. In a week or so I should do some re-evaluation to make sure I am allocated correctly if there is further decline…

  16. I am inspired by the fact that you are so young and know all this. Your blog continues to be grounding. Incidentally I am one of the bad drivers, at least I am aware of it and bike commute or bus.

  17. Granted, I haven’t been actively investing or watching my investments for very long. But so far, I feel like a sane and rational adult in a household full of toddlers and teenagers. For me, various temporary events, reports, rate adjustments, etc. have nothing to do with the likely long term success of the companies where I put my money when they seemed undervalued. So, remain calm and rational and I keep my money where it is. However, I watch these relatively small events and reports trigger disproportionately dramatic responses and reactions by other investors, and I’m sorta amazed. I wish their severe reactions didn’t impact my portfolio (at least in the short-term) but I’m not sure how to avoid that.

    Can someone explain why the market appears so emotionally volatile? Does it make me rational or obtuse to completely ignore this sorta stuff? Or does it simply depend on the type of investor (professional v. small time).

  18. I actually went shopping. A 5-6% discount on good stocks is hard to pass by.

  19. “Remember, for every trade there is a buyer and a seller. The buyer thinks he?s getting a good deal. The seller think she?s getting a good deal. Both can?t be right.”

    These are the only lines in your post I have to disagree with, otherwise, great post!

    The reason I have to disagree is because of that last line where you say they both can’t be right. That view is innacurate when concerned with the immediate transaction. A buyer and seller wouldn’t enter into a deal unless they both thought it was beneficial to themselves – no one is forcing them to transact. Where the confusion comes in is when you factor in time. You can sort of look back a year later and see who was “right.” But at the time of the transaction, there is no winner and no loser, both parties are winners.

  20. I don’t like total market funds or index funds, simply cause they treat two (equally weighted companies) the same, regardless of the effectiveness of management, or the sustainability of their business model.

    Now if you don’t have the time (or care) to evaluate companies on a one to one basis owning a whole market funds or index funds is fine. I just think if you have the time to *do real research* you will do better.

    I did not sell yesterday, because:

    1) When I’ve chosen a stock to buy, it’s usually for the long term. Once in a while, I will pick up a fad stock (Apple/iPod), but I currently don’t own any.
    2) the same factors for which I bought the stock still exist.
    3) the stocks are not overvalued by my measure.

  21. Eh, I’m pissed about wiping out of all my gains in my 529 plan, but that’s because I’ll need it in a year and a half vs 40+ years for retirement accounts.

    I wish my bonus check would arrive already! Then I could take advantage of the “sale” prices in the market.

  22. Julie: when I wander over to the business department, my colleagues are pretty strong believers in efficient market theory. You see a lot of volatility because the market is reacting quickly to all kinds of small pieces of information that you are largely unaware of.

    I personally believe there is some of that, and some good old-fashioned chaos, just like you see when you play a game of musical chairs. There are a lot of us essentially trying to achieve the same kinds of goals and it necessitates little shift by its inherent nature.

    Chris: you are totally right that there is more to a buy-sell arrangement than one is right and one is wrong. I sold two stocks recently because I wanted to free some money for a land purchase opportunity that arose for me. It wasn’t that I didn’t think my stocks were good any more. In fact, I expected both to continue to do well, but the sell was good for me because I had another use for that money.

    Simililarly and older person may be (correctly) selling good stocks to fund retirement when a younger person is buying them. Completely sensible on both sides.

  23. Jonathon: You are right not to check your overall balance but you should check the make-up of your portfolio. You are weighted way too heavily in emerging markets and REITS they make-up almost 25% of your portfolio if you count the REITS in your other index funds. Chasing hot funds–there is a lot of scared money in those sectors and people see housing prices going up and up especially on the coasts so they become enamered with REITS. As soon as interest rates rise and they will you lose too much for a retirement portfolio.

  24. Well, the TA in me says to lighten up on the bounce and then add some shorts on a breakdown.

  25. Jonathan wrote: “Remember, for every trade there is a buyer and a seller. The buyer thinks he?s getting a good deal. The seller think she?s getting a good deal. ”

    Jonathan, sometimes seller sells of in panic and loses money…and sometimes buyer buys because latest earnings just came out and it was stellar so buyer quickly jumps in to buy the stock at no matter what price it is…eventhough it might not be a good deal, and he/she knows it.

  26. Jonathan, re your point about quant funds…

    In my view these seem to be best for “normal” market conditions – often there are built in buy/sell triggers, more sophisticated models will incorporate an attempt to “learn” the market by incorporating volatiltiy on a realtime basis. So in a trending market, in a flat market, in a predictably volatile market (emerging market currencies) computer models developed by quants will work well. The trouble starts when there are sudden moves (Russia default/LTCM type events) where options that may be far out of the money suddenly kick in (so you have to sell in a plunging market for example) – no amount of modeling can help you here… in these cases dollar cost averaging would actually give you a better shot (over the long term, of course)…

    So, these types of quantitative strategies may eke out an extra couple bps on average, but just when you need protection, they would likely fail….

    my view anyway!

  27. Don, I think I kind of follow you. However, on my MyYahoo! page, I have my stocks listed out, right next to several sources of business news. If the story to the right of my stocks says “Stocks down due to report of XYZ,” all of my stocks are down, despite how insignificant and temporary the report seems. If a report says “Stocks up due to report of ABC,” all of my stocks are up, despite that this report really shouldn’t actually impact my individual stock price, because isn’t it supposed to be based on individual company’s likelihood of long-term profitability?

    So, I think I’m aware of what is driving the volatility. It just amazes me that first, the overall market is effected by these things. In a capitalist society, shouldn’t one’s gain be another’s loss? Shouldn’t people be looking at companies more individually? Also, it amazes me just how STRONG the reactions are — I lose several hundred dollars in a day simply because of a report that the economy is strong, so the feds MIGHT raise interest rates in a few months? Again, I might be really naive, but I just don’t get it.

  28. I sold most of my stocks and mutual funds on 2/27 and 2/28.

    Was I panic? No.

    The market has been bull for many months and you guys are still so calm and so optimistic about the market. It is not a good sign, at least from a short term perspective.

    I expect to see DJ hits 11,000 in the next few months. If you think 5%-6% off is a “sale”, then I will tell you 10%-15% down is what they call a “market correction.” It is just the beginning from my point of view.

  29. Julie: one thing that makes the market move in tandem is big money like mutual funds. Consider how often Jonathan proclaims the benefit of broad market exposure via low-cost index funds. Many many people follow that same philosophy. I do. Now if I sell some of my portfolio, and a bunch of like-minded people do too, what is that going to do? It’s going to force our broadly diversified mutual fund companies to make moves that are market-wide in effect.

    I’m not saying that big moves of the whole market necessarily make sense. Some authors point to it as the inherent irrationality of the market. That was certainly my sense when I started watching “the dance.” My academic colleagues feel differently. They would say that an announcement from the fed chair has an impact on stocks broadly because of what it entails for the whole economy. I.e. that quick broad move you note is the efficient and fast response of the market to new information.

  30. Don, that makes a little more sense. Thanks!

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