With Jonathan Clements, Founder and Editor of Humble Dollar and Personal Finance Author
Jonathan Clements is Founder and Editor of Humble Dollar and the author of several books on personal finance. His latest book, From Here to Financial Happiness: Enrich Your Life in Just 77 Days, offers tips and tricks to bolster your personal finances. This week, Jonathan spoke with Steve and shared some insights on how you can navigate the ups and downs of the stock market.
With Every Up There Comes A Down
“One out of every four years, the stock market ends up having a down year,” Jonathan said. And the truth is that the stock market has seen down years in the not-so-distant past, “but nothing that feels like what we’re dealing with currently” he continued. The market seems to be responding to something dramatic happening in the global market. “There’s definitely the potential for this to be the biggest decline we’ve seen since 2008,” Jonathan went on to say. And while he’s not flat out predicting the market to tank, he believes it could happen.
“There’s really two things to look for when making predictions about the market,” Steve said. Those two things? The direction trend of the market and time. But the new element we need to consider right now is the fact that the market dropped 10% in just a couple of weeks. This is largely the result of the world responding to the novel coronavirus, COVID-19, and the global fear it’s causing.
“The coronavirus’ impact on the global economy, on our daily lives, and the fact that it could potentially kill you is an extraordinarily fearful set of circumstances; it’s not surprising that so many people are freaking out,” Jonathan said. There’s a lot to worry about, but perhaps the biggest issue is the uncertainty that the virus is causing. The market is naturally going to respond to people’s levels of uncertainty. The news, while a useful tool for spreading information, is also doing a good job of facilitating the spread of panic globally.
Unfortunately, when it comes to investing, we cannot control the financial markets, and the coronavirus is only making things more unpredictable. This isn’t the information anyone wants to hear, but for investors, it makes things particularly tricky. The only thing you can do in financial times like this is focus on the aspects of your investments that you can control.
How To Protect Your Investments
One thing you can do to protect your investments is to avoid borrowing money to invest. “Don’t use your margin account in order to increase the value of your securities; if something surprising happens, your finances will be hit harder than if you avoided leveraging your portfolio,” Steve pointed out.
“The problem with borrowing against your portfolio, borrowing on margin, is that you can be forced to sell stocks at the worst possible times, when the market is down,” Jonathan added. You need to make sure that you’re not only not heavily invested in a substantially leveraged portfolio, but also that the money you might need in the near future isn’t tied up in the stock market. The last thing you want or need to be doing in uncertain times is cashing out a huge chunk of your portfolio in order to pay for something like college tuition or even unexpected medical expenses.
Steve noted that it’s also wise to stay away from speculation games, namely, the options market. Pick strong companies with good balance sheets and good business prospects. You not only want to avoid leveraging your own portfolio but to avoid investing in companies that are heavily leveraged as well. You can also protect your investments by being conscientious of how much risk you’re taking. “You can control the degree of volatility in your portfolio by figuring out the percentage of stocks versus bonds you invest in,” Steve pointed out. The yield on bonds isn’t all that high, but in comparison to stock investments, there’s a much lower degree of risk.
Controlling Your Emotional Response To The Markets
One of the most common things people tend to do when the market fluctuates wildly is to respond emotionally. It’s a natural human reaction, especially when the market is down. And with the market dropping 10% almost overnight, most people’s kneejerk reaction is to extrapolate to the point of thinking they’re going to lose everything. “’Sell, sell, sell’ becomes the mantra,” Steve said. But, how do you counteract something that behavioral finance experts call ‘recency bias’?
“I think probably the best defense is to have some knowledge of investment history,” Jonathan commented. People tend to base their actions on an emotional response to things that have happened in the immediate past. But, if you look back at how the market fluctuates, when it goes down, it tends to come right back up. While there may come a day when the stock market doesn’t recover, history has shown us that it eventually comes back up. “And the number of down periods tend to be far less frequent than the up periods,” Steve added.
So, what does this mean for you? Educate yourself about the market and its movements before you react drastically. While it may be wise to cash in on some of your investments now, most of them will be safe if you leave them alone. It’s natural, when faced with volatile markets, to respond hastily in order to feel more in control. But the truth is that you may miss out on a lot of lucrative profits by doing so.
“The ability to sit quietly with a well-diversified portfolio and let it work for you over time sounds extraordinarily simple and easy, yet from a psychological point of view, it’s enormously hard to do,” Jonathan pointed out, especially during times of crisis, like the one the world is facing now with the severe and widespread outbreak of the novel coronavirus. “Often, the smartest strategy is to sit on your hands and ride it out. Nobody knows for sure exactly how things will turn out, but we do know that if you are diversified, keep costs low, manage your risks, and pay attention to your taxes, good things are likely to happen.”
Steve again emphasized the value of concentrating on the things you can control, such as how much you’re saving versus how much you’re spending. Jonathan agreed, saying, “If you want to make your portfolio grow for the long term, being a diligent saver is the number one virtue that you need to cultivate.”
You can find more personal finance and investing tips at humbledollar.com.
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.
Steve Pomeranz: With the markets so funky and volatile these days, who better to bring on the air than one of my favorite guests, Jonathan Clements, who will bring a fresh and reasonable perspective to all that we’re experiencing these days. Jonathan Clements, welcome to the program.
Jonathan Clements: Steve, it’s always a pleasure to be with you.
Steve Pomeranz: So I guess we’re in one of these periods, which we experience every couple of years, would you say?
Jonathan Clements: Yeah, well one out of four years and the stock market turns out to be a down year. We have had a down year in the not so distant past, but really nothing that feels like this. This feels like something dramatic is happening in the global economy that could affect corporate earnings in a big way. And hence, there is the potential for this decline to be a large one, to be the largest that we’ve seen since 2008 and 2009. I’m not predicting that it’s going to happen, but there definitely are the ingredients there for something big to happen.
Steve Pomeranz: So I’ve often said that when making predictions or looking ahead, there are two aspects to look for. There’s the direction as something going up or down and there’s time, the question of when it’s going to happen. I think a new element that enters into the conversation with what we’re experiencing now is also magnitude because a drop of 10% in a matter of a few weeks is incredibly dramatic and also gives you the feeling that there may be something else out there going on that you haven’t considered and therefore, it may add an element to your fear. What do you think about that?
Jonathan Clements: I think that’s absolutely correct, Steve. In dealing with the coronavirus and its impact on the global economy as well as on our daily lives and the prospect that you know maybe many of our friends could potentially die of this, this is an extraordinarily fearful set of circumstances and it’s not surprising that people are freaking out. There is a fair amount here to freak out about and part of the problem is the uncertainty. We just don’t know how rapidly the coronavirus is going to spread, how far it’s going to spread, and what precisely it’s going to mean for our daily lives and for the functioning of the global economy. Put that all together, and what you’re going to get are big swings in the stock market because the stock market, in a sense, this huge discounting machine, it’s looking out into the future and saying, “Are things going to be good? Are they going to be bad? Are they going to be very bad?” When the range of outcomes is as big as it is right now, you’re going to get those big stock market swings.
Steve Pomeranz: A lot of this is being driven by news, and I remember a week ago or so, I opened up the local paper and the headline was, “Virus explodes on the scene in the US.” Now I think we had two individuals that had been diagnosed with it or some small amount of individuals, and I really took exception to this word, “explodes” because that’s a fearful word. So a lot of this is being driven by the news, and it brings us back to what we as investors and as human beings need to remember about how we go forth in life successfully. One of those aspects is to figure out what we can control and what we can’t control, to accept the things that one cannot change, change the things that one can, and the wisdom to know the difference—the serenity prayer, which I think works very well with dealing with any kinds of fears. Let’s talk about some of the things that we can’t control at the moment, Jonathan.
Jonathan Clements: So the number one thing that we cannot control if we’re wearing our investment hat is we cannot control the financial markets. As you mentioned, Steve, it’s driven by the news and the news is scary. The media, slight digression, knows that the scarier the headlines, the more readers they’re going to get. So the headlines are going to be scary, and those scary headlines are going to drive the market and all of that for us as investors is out of our control. So you might as well just sit back and say, “I’m not going to be able to figure out what’s going to happen with the coronavirus. I’m not going to be able to figure out what it’s going to mean for global growth, and I’m not going to figure out what it means for the stock market. So I might as well just take all that, put it in a box, push it to one side and say, ‘I’m going to ignore that because I can’t do anything about it,’ and instead say, ‘So what I should do is focus on the stuff that I can control.’”
Steve Pomeranz: Right. Let’s talk about that with investments to begin with. One very important thing to do with your investments is make sure that you don’t borrow money to invest, that you don’t use your margin account in order to increase the value of your securities because if something surprising does happen, then you’re going to be hurt a lot more than if you didn’t leverage a portfolio. So things of that nature, just starting off with investments, is one of the things that you can control. Do not borrow money against your portfolio. If you have to or if you’re doing it for personal reasons, make sure there’s a huge cushion between the amount you borrow and the value of the portfolio. So that’s number one.
Jonathan Clements: In that context, Steve, the problem with borrowing against your portfolio, borrowing on margin, is that you can be forced to sell stocks at the worst possible time when the market is down a lot. So not only do you want to make sure that you’re not investing in a heavily margined account, but also you want to make sure that money that you’re going to need to spend to the near future isn’t sitting in the stock market. You don’t want to have to cash out part of your portfolio six months from now to pay your teenager’s college tuition bill because you currently got it sitting in the stock market. If there’s money that you need to spend in the near future, it should be out of stocks and probably nothing more adventurous than a short-term high-quality bond fund.
Steve Pomeranz: Yeah, and no matter how little it pays, the fact that you get your principal back when you need it and over a short term is more important. Also, don’t speculate. Don’t play the options market. Don’t play the commodities market. Stay away from speculations. If you like to pick individual stocks, make sure you pick good companies with good balance sheets and good business prospects and that they’re not leveraged too much as well because if things do happen that are bad, those companies are going to get in trouble as well. Diversification is the key if you don’t know what you’re doing. All right. So we talked about the stock market, but there’s a lot more that we can do personally to take care of things. I’m going to start this off. First of all, how much we save and how much we spend is under our control, right?
Jonathan Clements: That is the number one lever that’s at the control of the typical family. If you want to make your portfolio grow for the long term, being a diligence saver is the number one virtue that you need to cultivate. So if you’re concerned about what’s going on in the stock market today, if you’re worried about your economic future, what might happen if the economy slows, there are job layoffs, whatever it is, the best defense is having great savings habits and having a pile of money that you can turn to if things turn rough. So being a good saver is right up there, and if you feel like you’re spending too much every month, now is the time to start looking through those bills and saying, “Hey, maybe I should get a smaller cable package. Maybe I should cancel this streaming service. Maybe this isn’t the year to buy the new car,” whatever it is to keep your spending under control, take steps now before you have to take those steps.
Steve Pomeranz: And you’ll end up having to take those steps at the absolute wrong time, so you really want to prevent that now. Another aspect that is under our control is the amount of investment risk we take. Not everything has to be in the stock market. You mentioned having a little bit in cash for short-term needs, but even though the yield on these instruments is low, having some bonds in your portfolio or something other than stocks that represents little to no risk is also something that’s very important. You can control the degree of volatility in your portfolio by figuring out the percentage of stocks versus bonds. Any comment on that?
Jonathan Clements: Yeah. If you have gone through the past couple of weeks and you feel that you are unnerved by all this stock market volatility and you are taking too much risk, it’s not too late to do anything about this. The market is really not down a whole lot from its high. Meanwhile, share prices have almost quintupled since the low of March 2009. So even if you sell, at this point, you’re probably booking handsome gains. If you feel like you are taking more risks than you’re comfortable with, by all means, think about making a change. It’s not too late.
Steve Pomeranz: Right. Try not to be too greedy. Now there’s other things that you can do as well. You can watch how much you’re paying in investment costs. You can look at your portfolio’s tax efficiency, but I want to spend a few minutes that we have left talking about our emotional reaction to the ups and downs of the market. There are some proven factors of human behavior that we are all subject to. No matter how much learning we do or how much we hear these things, we have these internal feelings which get generated when things get a little fearsome. One of them is this idea of extrapolation, as an example. This idea, if the market’s going down, you’re going to extrapolate, it’s down 10% and it’s going to go down another 10%, and then the idea is that you’re going to lose everything and that’s the fear that’s driving you is to, “Sell, sell, sell,” becomes your mantra. That’s a dangerous idea. How do you counteract that, Jonathan?
Jonathan Clements: How do you counteract that tendency to extrapolate? How do you counteract what the experts in behavioral finance call, “recency bias”? Where we hank so much of our thinking about the future based on the immediate past. We tend to take the past extrapolated it into the future. I think probably the best defense is to have some knowledge of investment history. You look back and we’ve had periods like this where the market has gone down and, lo and behold, it comes right back up and it marches on towards a new high. Maybe the day will come when the US stock market does not recover, but everything in history tells us that what goes down eventually comes back up.
Steve Pomeranz: I think most people feel that what goes up will eventually go down. But mostly when you’re dealing with investments like stocks, when you’re dealing with capitalist societies, you’re talking about economies that grow over time. The number of down periods is much less than the up periods, and the market has shown a rate of growth that’s been quite above the rate of inflation. Over time, the market can actually be quite beneficial if you can get past these short-term feelings of fear. You mentioned recency bias. I mentioned extrapolation. I want to talk about hindsight bias because again, we feel that we know that the current bull market has lasted so long, but yet we feel that all of this is going to go away and that everybody’s waiting for the next shoe to drop.
Jonathan Clements: And people have been waiting for the next shoe to drop for years, Steve. For years and years, people have been anticipating that this bull market is going to come to an end and eventually they’re going to be right. Maybe they’re right, absolutely right now. We don’t know yet, but what happens is because we’re always looking at the market and we’re always making these predictions, a lot of people are predicting that the market is going to go down a lot, and they’ve been doing it for years, suddenly it happened and they say, “Yeah, I’m an investment genius. I forecasted this decline.”
It may have been they missed out on tens or hundreds of thousands of dollars while they were sitting on the sidelines because of this prediction, but now they feel that they’re correct and because they feel that they’re correct because of this hindsight bias, it emboldens them to start making even bigger investment bets. The risk is that those big investment bets come back to haunt you. What we should do today and what we should do year after year, is to have a well-diversified portfolio, not make those big investment bets, so that we’re not relying so much on our judgment, which is likely to be faulty.
Steve Pomeranz: When faced with danger, it is often our instinct to act, which makes us feel more in control of our destiny and it may, as you said, you may have predicted something that eventually comes to light. Yet for some reason, you’ve forgotten all of the opportunities that you have missed. One of the things you must realize is you must become humble with the idea that you really don’t know and that this call to action that is so natural for human beings can actually, when it comes to successful wealth creation, can work against you.
Jonathan Clements: The ability to sit quietly with a well-diversified portfolio and let it work for you over time, it sounds extraordinarily simple and easy, and yet from a psychological point of view, it’s enormously hard to do. At a time like this when we have this sense of crisis, it’s awfully hard not to act, but often the smartest strategy is indeed to just sit on your hands and ride it out because nobody has a crystal ball. Nobody knows what’s going to happen. What we do know is that if you are diversified, you keep costs low, you keep half an eye on taxes, you manage risk, and you’re there for the long haul, good things are highly likely to happen.
Steve Pomeranz: Doing nothing is actually an active decision unless you’re a teenager. I don’t think you’re really putting much thought into that, but for the rest of us, doing nothing… As an advisor, the number of years that I could have done something, the number of times, it’s numerous, and yet when going through all the processes we just discussed, the idea that you come to the end conclusion and it’s to do nothing, that was really a conclusion based on a lot of active thinking. So don’t confuse the two. They say that investing is simple, but it’s not easy. One of the reasons that it is not easy is that, once again, we all have this propensity and desire to act and doing nothing is a very difficult thing to do.
We are out of time, Jonathan, as time went by very quickly. My guest is Jonathan Clements, Founder and Editor of The Humble Dollar. He’s also the author of a fistful of finance personal finance books, including, From Here to Financial Happiness and How to Think About Money. Jonathan, thank you so much for joining me.
Jonathan Clements: Always a pleasure, Steve. Thanks for having me on.
Steve Pomeranz: And as you know, folks, my mission is always to educate my listeners and to remind them week after week, segment after segment that we love to get your questions because we do. So if you have a question about your portfolio, your kids, or your kids’ kids or your 401k, anything financial on your mind, go to our website and ask us that question and sign up for our weekly update as well where you’ll get in your inbox every single week, every single segment that we’ve done that week with the audio, with a transcript, with a summary and some other things for your enjoyment. Go to StevePomeranz.com to sign up or to ask us questions. That’s StevePomeranz.com.
