The late John Templeton was a patient investor who kept his head while others lost theirs. He didn't let near-term events push him off course. When times were bleakest, he'd produce a chart showing all the bull and bear markets back through the Great Depression. An updated version of that chart still makes its point: bear markets are followed by bull markets that tend to be longer in duration and greater in appreciation. But looking backward from deep inside a bear market, it can be hard to foresee better things for stocks. Now is such a time--stocks have shown signs of life lately but have a long way to go before they crawl out of the hole they're in.
Mind the midstream changes
In such an environment, you need to fight human nature. People tend to
overemphasise what's happened lately and adjust their behaviour based on
it. Sociologists call this recency bias. And it's a big reason there's
been a stampede out of stocks and into cash over the past year. But you
can't go back in time. Switching to cash now won't get you the
protection you needed before the crash. Rather, it is a bet that cash
will defy historical trends and outperform equities in the future. The
longer your time horizon, the more unlikely that is. And research shows
that a tiny percentage of trading days generate the bulk of the stock
market's returns over time, so trying to time the changing tides is
nearly impossible. Review your plan to avoid rash, ex-post facto
allocation moves that could hamper your progress toward a long-term goal.
The same forces apply to fund picks. Many top equity-fund managers have posted huge losses in the current bear market, while others have lost less. But that doesn't mean you should conduct a wholesale swap of the former for the latter. Mistakes were made and piles of capital were destroyed. But be leery of trying to win the last war. Just as it's not wise to chase performance into hot funds after they've had a big run-up, moving into more-moderate funds near the bottom of a trough could limit your returns in a rebound. If you've underestimated your risk tolerance or your goals have changed, adjustments should be made. But if your long-term target remains unchanged, tread lightly.
A short checklist
Before ditching a fund, review these three areas:
- its long-term record--this is a good sanity check because it helps limit the impact of recency bias
- the stability of its investment process and personnel
- the portfolio's prospects
If it passes muster on all three, you should think twice about ditching it.
One size doesn't fit all
There are fine funds of every stripe. The key is to pick one with a
risk/reward profile that matches your tolerances. Warren Buffett has
said he'd much rather earn a lumpy 15% a year over time than a smooth
12%. But not everyone can stomach that. The thing to guard against is
making changes at inopportune times based solely on a fund's recent
performance. Remember, changes made today are a bet on the future--not
the recent past--and the former rarely looks like the latter.
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