No one likes to see their investments go down in value, but that happens. But when they do, does that make you bad or dumb? No, of course not. But it sure feels that way when our investments are losing money. I can personally attest that when things aren’t working well, humans tend to feel the discomfort acutely. It’s understandable. The real issue goes beyond feeling the pain. Bigger problems happen when we react to that pain and start making changes in how we are invested.
Like most people, I have made that mistake many times. But fortunately I have learned how to avoid it, at least for the most part. So let me tell you a story about how I learned to stop worrying and love the bombing investment.
Almost five years ago, I invested in an aggressive foreign stock exchange traded fund. It looked at long-term trends in less developed countries’ stock markets, particularly how cheap they appeared to be. Everyone loves cheap, and I am no exception. The managers of the fund assembled impressive academic research to support their strategy of how to exploit this opportunity. After much more research on my part and plenty of thinking, I decided it made sense to have this in my own investment portfolio. So I bought it. And lucky me, I bought it within a month of its debut.
Over the next 18 months, the investment went down close to 30 percent. And while the overall market was also down at that time, it fared much, much better than my new investment. Which isn’t crazy, as it had more risk than a plain U.S. stock investment, but truthfully it still sucked. I researched more and did a lot of thinking, while the devil on my shoulder told me to stop accepting these losses and get out. And I almost did. But I didn’t.
The reason I didn’t is that I began to see that just because this investment had started out poorly didn’t mean it wasn’t a good investment. In fact, the investment hadn’t changed at all. It was still executing its strategy in the same way as when I bought it. And the premise for the investment still stood: Buying cheap assets and holding them for a long time has been pretty rewarding historically. And it had been less than two years since I bought it. Hardly long-term. The only thing that changed was the value of my money.
So what happened after this epiphany of sorts? It continued down another 17 percent. Yay. Grudgingly, with the support of my new knowledge, I simply continued to hold. But then, when no one was looking, it found its legs and went up 60 percent over the next two years. My previous steep losses were now a small but hard-fought gain.
So what’s the lesson here? It’s simply that what makes a reasonable investment isn’t its recent performance, but whether it has been chosen based on a robust process and sound thinking.
Your ultra-safe Treasuries have been underwhelming? Keep them; you’ll thank me later when things get ugly. Small-company stocks getting pummeled while big stocks soar? Keep them until small becomes beautiful again. It’ll happen. Foreign stocks sucking wind versus U.S. stocks? Keep them for when the unthinkable happens, and they do well versus our U.S. markets. It happens quite frequently over the long term. It doesn’t matter how they have done recently. What matters is whether they belong in your portfolio.
If you have a well-diversified portfolio, whatever your goals or risk tolerance, parts of it will be disappointing pretty much all the time. But decades of research into portfolio design has shown that a diversified portfolio allows you to garner acceptable returns while providing you with a level of protection against steep and debilitating drops. It just makes sense, and it should be an integral part of your investment planning process.
If you don’t want to do this type of work yourself, go get help from a professional. Ask specifically about how their investment process works. Don’t let them talk to you about how well they have done recently— it’s worthless. Strong short-term outperformance is more likely about luck and not about competence. A good process seeks to lower or even eliminate luck as something that determines your returns. And a good process entails not only having well-reasoned choices of what to invest in, but also how to adapt as the years go by.
John Kageleiry is a business writer and financial planner. Have a question for “Finance 101”? Email it to firstname.lastname@example.org.