Know Thyself

March 21, 2022

Short articles should never begin with a quote from Socrates, but here goes… “To know thyself is the beginning of wisdom.” There is some debate as to what Socrates meant. The favored theory is that true wisdom is knowing what you do not know (which in my case is a lot). I mention the quote though for different reasons. This piece of Ancient Greek philosophy has great relevance to developing, and living with, our investment strategies.

Until early 2022 those investors aboard the US equity market boat enjoyed over a decade of smooth sailing disturbed only occasionally by a few passing squalls. Such a successful period has allowed many, including the ‘professionals,’ to develop an inflated sense of their capabilities as ‘sailors.’ We are suddenly in the midst of a major storm. Are you running for the lifeboat?

Research has shown that the belief in timing the markets is highly seductive but ultimately damaging to investment success. To use another Greek reference, market timing is a siren song from Medusa for the unwary investor. Many ‘market-timing’ decisions made by individuals are driven by a sudden realization that the risk in their portfolios is too much to bear leading to a knee-jerk decision to sell. The result is the opposite of the Warren Buffet mantra to “Be fearful when others are greedy and greedy when others are fearful.” What makes all this worse is that the pain from a loss invariably outweighs the satisfaction from a gain, especially when money is involved.

So going back to Socrates, in order to devise a robust investment strategy, we must know ourselves. We must think not only of how we feel when times are good but how we will react when the inevitable downturns in equity markets take place. If we get this assessment of personal risk tolerance right, we will have an investment strategy that does not keep us awake at night even when Mad Money is going through a period of extra madness. If we fail to assess our risk tolerance realistically, we may panic when markets fall. The result will be selling at lower prices (joining those who are fearful) and then sitting hesitantly on the sidelines with no appetite to reenter the markets until prices are high again (this time joining the greedy).

Of course, there must be balance. Adopting a conservative strategy can lead to frustration when markets are growing if you feel you are not keeping pace.

We should never forget that investing exposes us to issues and decisions which can be heavily driven by emotion. Moreover, investment value is destroyed when emotional distress leads to panic selling or emotional greed leads to following the herd. Building wealth through investments takes time, judgment, and calm and is best achieved through a well-crafted investment plan that is consistent with the emotions of the investor. Without such a plan, we have no moorings when the storm hits.

Richard Rushton