Unfortunately Corporal Jones didn’t heed his own words, proceeding to panic with often hilarious results.
Panic is a response to fear, part of our normal make up as humans. However, Dr Steve Peters who wrote “The Chimp Paradox” might argue that it is not a rational response when stock markets around the world are falling. It is, of course, a typical response to the noise from the media. Bad news travels quickest. Steve Peters argues that we all have a chimpanzee in our heads – that part of our being that can sometimes be irrational, angry and emotional. The human in our head is rational, fact-based, analyses data and operates a balanced judgement. One of the secrets to a successful life, he argues, lies in controlling our chimp.
The academic approach to investing, backed up by Nobel Prize winning research, is rational, fact-based, analyses data and operates a balanced judgement. It tells us that in the short term the stock market will always be volatile, a bit like a rollercoaster. Lexington Wealth Management takes the view that nobody should be investing in the stock market for the short term. It also tells us that, in the long term, it will bring rewards.
Money that might be needed in the next two years should be held in cash and allocated to the short term jar. Liquid capital should always be available particularly when stock markets are falling.
Medium term money, money which might be needed in three, four or five years’ time, should not be invested in the stock market either. Medium term money should be lent to governments and companies (short dated bonds and gilts) and over a minimum timeframe of two years should never post a negative return – although we should always remember that the future may be different from the past. The medium term money will also fluctuate in value from one day to the next.
The long term jar, which does invest in the stock market, is for money that is left over after having filled the short and medium term jars. Over most five year periods, the stock market is likely to be higher at the end than it was at the beginning. The evidence tells us this.
Even for those clients with greater appetites for risk, very few have more than 60% of their long term money invested in stock markets. Not all stock markets around the world fall and rise at the same time as the others. Just because stock markets fall, short dated bonds and gilts (and indeed commercial property) do not necessarily fall. This principle of diversification helps to smooth returns.
The evidence tells us that, in the long run, bonds will perform better than cash and equities will perform better than bonds. At times of market distress we need to have faith in the future. Despite all of the scare stories that we read, see and hear it does not appear that the fundamental premise of risk and return is mistaken. After all, no one in their right mind would take additional risk unless there was a reasonable prospect of a better return.
What should we do? Boring though it sounds, the correct answer is to stick with the plan. Nobody, in advance, can predict when markets will go down, whether they will go down more or when they will begin to go up again. Many will give an opinion but they can’t predict the future, not even the gypsy fortune teller. No rational person would expect the gypsy to know the future; yet many rational people choose to believe financial experts” who profess to have the same visionary skill!