It was hard to miss the panic among investors over Brexit -- the British electorate's surprising vote to leave the European Union. And what did you do? Hopefully, nothing. That's what I advised before the opening last Friday in a bulletin to subscribers of my free newsletter (sign up at TerrySavage.com).
Yes, global growth is likely to slow as a result of Brexit. Yes, the strong dollar is bad for U.S. business, as it will make it more difficult to sell products overseas. Reduced sales and declining profits are bad for job growth -- and for stock prices. And, yes, maybe you (and your adviser) should review your investment strategy now that things have quieted down.
But the most recent market panic (and subsequent recovery) demonstrate the importance of having an investment plan -- and sticking to it in a crisis. Here are three lessons from the market.
--Risk happens fast! It's an old Wall Street saying. And here's another bit of street wisdom: Risk is the price you never thought you'd have to pay.
The time to think about risk is not in the middle of a crisis. Risk must be calculated in advance, or after things settle down and you've had a demonstration of how your heart races when risk becomes apparent.
Thinking about risk is more than an exercise in calculating how much you could win, or lose, if the market goes to unexpected extremes. Obviously, you could win a lot, or lose it all. But the real analysis is around what happens to your life if you do sustain immediate steep losses.
Will you be forced to sell stocks at huge losses to fund your lifestyle -- or your required minimum distributions from an IRA (based on prices at the previous year-end)? Or can you ride it out, knowing that you won't need that money for many years until you retire?
--Diversification is important. Owning different kinds of assets in different proportions is not a recipe for beef stew. It is a recipe for peace of mind. This is not a question of just being "in" or "out" of the market. It's about having assets that typically move in different directions from the stock market -- or not at all -- and in the appropriate proportions.
Part of diversification is safeguarding what I call "chicken money" -- money you cannot afford to lose. Chicken money belongs in low-yielding, no-risk investments like bank CDs, money market funds or Treasury bills. It may seem foolish to leave cash in investments earning almost no interest. But chicken money has an important role in your financial plan. It lets you sleep at night! More importantly, it lets you ride out the volatility in the stock market without panic.
Owning a counter-investment to the stock market, such as gold, can also provide a balance that lets you ride out stock market volatility. You can own gold stocks, gold share mutual funds, and exchange traded fund (ETF) such as GLD to easily create this exposure to gold in your investment portfolio.
--Discipline is essential. Did you have self-discipline in the midst of the panic? It's easy to see the right path in hindsight but far more difficult to stick to your plan in a crisis. And that's the essential ingredient: a well-made plan gives you the courage to avoid panic.
If you understand risk and your own tolerance for it, if you hedge your bets by having liquidity and profit potential in crisis, and if you can stick to your plan when everyone is panicking, you are well positioned to be a financial winner in the very long-term. And that's The Savage Truth.