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Wednesday, December 14, 2011

Ducking thunder

It's hard not to feel a bit shell-shocked by current events. Each piece of bad news makes a person want to duck and cover until the storm passes. Although I understand this feeling and can sympathize with it, I don't think it's constructive.
When you hear a loud clap of thunder, it's hard not to duck. The problem is that by the time you've heard the loud noise, it's much too late to do anything about it (not that ducking would help anyway). The danger is long past and you're just reacting instinctually and uselessly at that point.

The same is true in financial markets. Unless you're a professional trader working at one of the world's financial centers, by the time you hear the bad news it has long ago been reflected in security prices. Whether it was Baron von Rothschild 200 years ago or instantaneous computer trading today, you and I are not going to benefit from trading on the news.

That doesn't mean we can't interpret the news more intelligently and act on it in the fullness of time, but thinking that we can duck and cover at the sound of thunder is total folly.

This reminds me of my experience in pilot training. Not surprisingly, you don't want pilots to panic or freak out when an emergency occurs. Our human instincts don't serve us well in the cockpit, so they train pilots through repetition--in a full-motion simulator--to keep their cool in emergencies and successfully deal with problems.  

We called it "dial-a-death" because the instructor pilot literally had a dial where he chose the emergency you were to handle. The first several times you were given a tough emergency, it was hard not to freak out, but over time you could learn to keep your cool even under the toughest of circumstances. For me, the key was to breath deeply and get very focused on properly diagnosing the problem and then meticulously taking corrective action. If you sat there thinking about the consequences and how worried you were, you were doomed.

I think this analogy is perfect for financial markets, too. We need to be ready for emergencies by preparing ourselves mentally. We need to expect things to go wrong instead of hoping, uselessly, that they won't. We need to know how to act when things go wrong so our instinctual desire to duck is suppressed and we do what we know we need to do. We need to focus on controlling the things we can control instead of wishing we could control the things we can't.

How do we prepare for financial emergencies? Go into the situation with your financial house in order: 
  • spend less than you make
  • save the difference (pay your future self, first)
  • invest your savings wisely (by being prepared for both good and bad market conditions that you know will happen, but not when)
  • have enough cash at your disposal to handle life's inconveniences
  • get enough insurance
  • set up an estate plan  

Also, know what not to do: 
  • panicking won't help
  • don't assume see can see bad financial conditions coming (don't worry, no one can consistently)
  • don't assume that bad times won't come
  • don't believe you can "go to the sidelines" until the storm is over
  • don't try to time when to get out and get back in (you will almost always do both way too late)
  • don't inundate yourself with bad news that makes you want jump out a window (good pilots don't stare at burning engines, they focus instead on putting the fire out)

If you're more opportunistic (and this is clearly not for everyone, just like flying airplanes), be ready to benefit from others' panic. Be ready to sell your safest holdings and buy what the panicky sellers are abandoning recklessly. Financial panics are always the best time to invest, and precisely when your instincts most desire to seek cover.  

Just like pilots can learn to handle terrifying emergencies, you can learn to handle and profit from financial panics. Be prepared, have a plan, take deep breaths, and don't try to duck--it's already too late.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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