Stock markets have had a rough couple of weeks to start the New Year. They recovered a bit Friday but they are still down considerably since January 1. Although the year is young the Dow has already suffered several triple-digit losses, sometimes on consecutive days.
When this happens people become restless and wonder what they should do with the money they have invested in stocks. My short answer is to turn an old cliché on its head and tell them, don’t just do something, stand there. Then I sometimes share with them a story about one of my favorite sports to drive the point home.
Penalty Kicks and Investing
I love the beautiful game, the world’s game, fútbol, which is known in the United States as soccer. I grew up playing soccer and I have spent much of the last twenty years coaching two of my daughters’ teams. I have attended a World Cup game, I am a big fan of Real Salt Lake of the MLS, and I loved watching the World Cup last summer. To paraphrase the old Saturday Night Live skit, “Fútbol been berry, berry good to me.”
Penalty kicks are an important part of soccer. In a penalty kick the ball is placed on a spot just 12 yards out from the center of the goal. A player is then allowed to take a free shot with only the keeper defending the goal.
With the ball coming at close to 100 mph goalies have only a fraction of a second to react. It is definitely a crisis situation for a goalie, which is proved by the statistics. At the top levels of the sport over 80% of penalty kicks result in a goal.
To try and improve the odds goalies are taught not to wait until the ball is kicked to react. Instead, they are taught to guess which side of the goal the ball will be shot to and start their dive in that direction as the ball is being kicked. Does this strategy really improve the odds of a goalie making a save?
An interesting study was done of 286 penalty kicks from European and South American professional leagues, as well as European championships and World Cup games. The study showed that about a third of the penalty kicks were directed at either corner of the goal, but the other third were shot towards the center of the goal.
The conclusion of the study was that more penalty kicks would be saved if goalies just stood in the center of the goal and reacted to the ball as it was shot. Indeed, the study concluded that standing in the center of the goal would increase the keeper’s chances of making a save from 13% to 33%.
In spite of the evidence this strategy is rarely, if ever, used. The reason is that in a crisis humans have a bias to action. When things are going badly we feel like we must do something, even if it is the wrong thing.
For a goalie, diving the wrong way is seen as better than standing and watching the ball go into the net. Diving at least shows that they are paying attention and trying. However, since results are more important than appearance, goalies should instead be told, in essence, “don’t just do something, stand there.”
In investing, as in trying to save penalty kicks, the best advice when the market goes crazy is to do nothing. Or at least nothing new. Changing your strategy in a time of crisis is likely to lead to mistakes that will make things worse. Resist the bias to action and stick to your long term investment plan.
Standing and doing nothing when the markets go crazy works best if you have a long-term investment plan that makes sense. In other words, standing and doing nothing only works if you are standing in the middle of the goal.
If you are taking way too much or way too little risk for your situation your chance for success decreases. This would be like a goalie standing and doing nothing in one corner of the goal during a penalty kick, leaving 90% of the goal open. Before the next market crisis hits make sure you have a long-term investment plan tailored to your unique situation.
Rebalancing needs to be part of your long-term plan. Say, for example, your long-term plan is to have 75% of your money invested in stocks and 25% invested bonds. If the stock market goes through a bad spell and loses 20% your stock allocation relative to bonds would drop.
Your mind will tell you to follow everyone else and sell stocks as their value drops, but rebalancing will force you to buy more stocks instead, which is the correct move. Rebalancing forces you to dive in the right direction even though your brain is telling you to follow the crowd and dive the wrong way.
- Develop a long-term investment plan based on your unique situation. Posts I have written about how much risk you need to take, how much risk you are willing to take, and how much risk is wise for you to take will help you get started.
- Make rebalancing part of your plan. Rebalancing should be done at least once a year, but can be done more often, especially if the markets make big moves in either direction.
- Decide in advance that when the next crisis comes you won’t succumb to the bias for action. Instead, you will stick to your long-term plan. You will have the courage to not just do something, but stand there.