The other day I saw a cartoon of a turkey jogging on a treadmill. Hanging on the wall behind the turkey was a calendar turned to the month of November with a Thursday late in the month circled in red. By getting fit the turkey was hoping to make himself unfit for Thanksgiving dinner.
The cartoon reminded me of a story told by Nassim Taleb in his book The Black Swan. The story is about a turkey living on a farm. At first the turkey is wary of humans, but each day the farmer provides ample food and water and takes care of the turkey’s every need. As time passes the turkey grows more and more trusting. He comes to believe that the farmer is his friend, and is looking out for his best interest.
This all changes drastically on a certain Wednesday afternoon in November when the farmer slaughters the turkey for Thanksgiving dinner. Speaking of the turkey Taleb says, “Its confidence increased as the number of feedings grew, and it felt increasingly safe even though the slaughter was more and more imminent. Consider that the feeling of safety reached its maximum when the risk was at its highest.”
As with Taleb’s turkey, your investments are most at risk when everything seems to be going well. Conversely, the safest time to invest is when all the news is bad.
Prior to becoming a best-selling author Taleb was a bond trader. In this profession he noticed something interesting. In Taleb’s words, “…at any point in time, the richest traders are often the worst traders.” Taleb explains this is because they only know one way to trade, and the market just happened to favor their method at that particular time. Taleb also noticed that when the market changed these traders usually “blew up” or lost most of what they had gained. These traders are like trusting turkeys right before thanksgiving.
The best investors, like the turkey on the treadmill, see the coming danger and take steps to profit from it. The world’s most successful investor, Warren Buffett, has been very successful investing when the outlook is poor. Buffett states, “The most common cause of low prices is pessimism….We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It is optimism that is the enemy of the rational buyer.”
How can you be like the turkey on the treadmill instead of the turkey on the Thanksgiving table? These strategies will help:
- Determine how much of your money you should place at risk in the market based on how much risk you need to take, how much risk is wise for you to take, and how much risk you are willing to take.
- Invest a set amount regularly in all market conditions. This is called dollar-cost averaging, and it means that you will buy more shares when prices are low and less shares when prices are high.
- Rebalance your portfolio at least once a year back to the asset allocation percentages you decided on in step 1. This will mean selling some assets that have done well, and buying assets that have done poorly.
- Stick to your plan, especially when everyone else is panicking. This will create the favorable prices Buffett looks for.
Following these steps will keep your investments in shape. You will still lose a few feathers at times but at least you won’t end up getting slaughtered for Thanksgiving dinner.