The common advice thrown around is to stay fully invested all the time and ride out the volatility. If you missed just five of the best days, your returns would drop by 38%!
You’ll be fine if you can hold through the bad days and just sit through till the cycle swings, no matter how bad things are. By the spreadsheet, staying fully invested and being unaffected by volatility is probably the best strategy to optimize returns for investors.
But as Morgan Housel says, “You’re not a spreadsheet. You’re a person. A screwed up, emotional person.”
How well are you sleeping?
As a rule-of-thumb, the percent of your portfolio you should have in cash should be the percentage that lets you sleep well even if your portfolio drops by 50%.
The problem is that when we conduct this exercise in good times, we fail to take into account the narrative.
Drawdowns of 50% typically accompany “disasters” such as war, inflation, stagflation, unemployment, etc.
If you visualize a 50% drawdown in the context of a healthy economy, it is impossible to determine your real risk tolerance.
What if you are fully invested?
It’s not fun to sit through a drawdown.
If it’s affecting your sleep, health or relationships, you’ve overinvested. You may want to reassess your portfolio.
In any case, the following is helpful:
#1 Zoom out. In the short run, this looks like a sharp drawdown. In the long run, it will seem like just another blip.
#2 Stop reading the financial news. Especially those that don’t charge a subscription fee. You are paying with your attention, and pessimism is the product.
#3 Don’t live your life by the stock market. Do something fun with your family, go for a walk. Your life is more than these flashing numbers.
Ready to deploy cash?
Well, if you are sitting on a truckload of cash during this drawdown but aren’t sure what to buy, indexing is a great way to get started with investing.
A rosy outlook and a good valuation seldom go hand-in-hand. It is during pessimistic moments like these where valuations come down significantly. Setting investors up for the next bull run.
If you have interest in studying businesses and want to try your hand at active investing, build up your stocks watchlist with my research reports.
My research report is between 15 to 25 pages long, and it will help you get up to speed on these companies in the shortest amount of time.
In investing, a cheap valuation and a rosy outlook never go hand-in-hand. Become a member and quickly build up your knowledge base of high-quality businesses.