When markets are in free fall, and bargains abound, investors should be elated. The question is: do you buy as opportunities arise or hold out for a better (lower) price?
This question was posed by Bruce Greenwald to a 2008 panel. Here was Seth Klarman’s answer:
I think that you buy one security at time. And if somebody wants to sell you something at at sixty cents, that’s worth par, you buy it because you don’t know if tomorrow someone will sell it to you at 50 or if it will be at 70 or 90.
That’s good advice in general because timing the bottom of anything is impossible without a lot of luck. It’s not even worth trying.
However, I think it helps to remember how investors reacted in ’08. Very few were ecstatic. Almost everyone was nervous, afraid, paralyzed, panicked… How many investors claimed to be “waiting for a better opportunity” while sitting on cash?
On paper, the idea that if something is a bargain at $50, all else equal, it should be a better bargain at half the price. In theory, nobody should flinch at buying. In reality, theory is often tossed out the window.
Pulling the trigger in late 2008/early 2009 was a huge accomplishment. But sitting on your hands felt a lot safer than buying. Buying came with extra baggage like watching whatever you bought fall further in price while second-guessing whether you made the right choice (that was my experience).
Holding on in a bear market is the second hardest thing to do, right behind buying. That’s why the eventual payoff is so high. Both require a plan of attack way before the decline arrives in order to come out (mostly) unscathed. Jeremy Grantham explained it this way:
Every decline will enhance the beauty of cash until, as some of us experienced in 1974, “terminal paralysis” sets in. Those who were over invested will be catatonic and just sit and pray. Those few who look brilliant, oozing cash, will not want to easily give up their brilliance. So almost everyone is watching and waiting with their inertia beginning to set like concrete. Typically, those with a lot of cash will miss a very large chunk of the market recovery.
There is only one cure for terminal paralysis: you absolutely must have a battle plan for reinvestment and stick to it. Since every action must overcome paralysis, what I recommend is a few large steps, not many small ones. A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer…
It is particularly important to have a clear definition of what it will take for you to be fully invested…
Life is simple: if you invest too much too soon you will regret it; “How could you have done this with the economy so bad, the market in free fall, and the history books screaming about overruns?” On the other hand, if you invest too little after talking about handsome potential returns and the market rallies, you deserve to be shot. We have tried to model these competing costs and regrets. You should try to do the same. If you can’t, a simple clear battle plan – even if it comes directly from your stomach – will be far better in a meltdown than none at all.
How you act in the next bear market will have a big impact on your long-term returns. The way to avoid the emotional decisions we’re all susceptible to in a chaotic market is to make the decision well in advance and commit to it.
James Montier shares one simple example of what Sir John Templeton would do to avoid emotionally charged decisions:
Sir John’s great-niece, Lauren C. Templeton, provides us with the strategy her uncle used to overcome this obstacle in her book, Investing the Templeton Way:
There are clear psychological challenges to maintaining a clear head during a sharp sell off. One way Uncle John used to handle this was to make his buy decisions well before a sell off occurred. During his years managing the Templeton Funds, he always kept a “wish list” of securities representing companies that he believed were well run but priced too high . . . he often had standing orders with his brokers to purchase those wish list stocks if for some reason the market sold off enough to drag their prices down to levels at which he considered them a bargain.
This prime example of pre-commitment in the face of a known empathy gap is exactly what you should seek to emulate in your investment strategies. Sir John knew that on the day the market or stock was down say 40 percent he wouldn ’t have the discipline to execute a buy. But, by placing buy orders well below the market price, it becomes easier to buy when faced with despondent selling. This is a simple but highly effective way of removing emotion from the situation.
A battle plan lays out exactly what to do next. All it does is replace a fear-driven choice with a rational one you made ahead of time. It’s a simple way to improve behavior when it’s needed most.
Graham & Dodd Breakfast Event 2008
Reinvesting When Terrified – J. Grantham 2009
The Little Book of Behavioral Investing – J. Montier
- The Time/Decision Gap – S. Godin
- About Making Mistakes in Science – SYFY Wire
- There Is More to Behavioral Economics Than Biases and Fallacies – Behavioral Scientist
- Most Americans Still Think They Have Above Average Intelligence – Research Digest
- Lessons from Jim O’Shaughnessy – 25IQ
- Real World vs. Book Knowledge – M. Housel
- Rising Corporate Debt: Peril or Promise? – McKinsey
- Slow Money Crypto – Medium
- Being 30, Then and Now – Axios
- What Makes People the Most Happy – Flowing Data
- Which Process to Trust? – Inside the Pylon
- Truth, Disrupted – HBR