Mindless Money 4/5: Stay Resilient, Be Prepared

26th July 2012

Every so often in an investor's lifetime the markets will throw us a completely unexpected curve ball.  Markets will fall off a cliff or soar off into the stratosphere.

Whether we like it or not, if we invest in the markets for long enough we will be exposed to events that we have no experience of.  How we deal with these will make a major difference to our returns over an investing lifetime.

Developing a certain resilience to this type of problem means that you have a decent understanding of stockmarket history and that you keep it in mind all the time.  Basically, if you don't have an understanding of the problems that can occur with your investments then you don't have the basics of a resilient approach to investing.

At the heart of this problem are our emotional responses to emotional events.  When markets soar and our closest friends are making tons of money with no other analysis than following the shoeshine boy's tips or they're crashing and taking our life savings with them our instinctive reactions are guided not by rational thought but by emotional reactions.

The oft-quoted truth, that most investors buy near the top and sell near the bottom of market cycles, is simply the external evidence of our emotional neurology.  It's also a perfectly hopeless way of investing.  Emotional resilience is as much a part of a good investor' psyche as skilful stock analysis.

Developing emotional resilience is, in part, about experience.  Nothing else prepares you for the sickening jolts of an investing career.  However, you can develop some understanding of the possible trajectories of markets by doing some careful studying of history.

This reliance on history needs to be kept in perspective.  How many times have you heard the current crisis compared to one of those of the dim and distant past, such as 1929 or 1973?  History doesn't repeat in such simplistic ways – it's always contingent: what happened in the past was just one possible course of events.  That's why all those wise predictions based on false historical analogies never come true: we're still waiting for the next Great Depression.

No, the proper use of history is an understanding of what could happen, a contrafactual baseline which we can refer to when we find ourselves in one of the inevitable economic storms that will occur from time to time. These are scary, no matter how many times you go through them, and expecting that you can simply ride these out without going through the normal cycle of fear, doubt, uncertainty, greed, rage and resignation is foolish.

Your strategy may be to sit tight, on the basis that you don't need the capital and you've carefully invested in stocks which will stand the test of any unexpected economic downturn.  It may be to carefully hedge your portfolio.  It could be any number of things apart from the one that most investors adopt – to sit in the headlights like a stunned rabbit, before exiting in panic near the market bottom.

Continue reading…


More on Mindful Money:

Mindless Money 1/5: Focus on Failure

Mindless Money 2/5: Don't oversimplify

Mindless Money 3/5: Hold the Big Picture

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24 thoughts on “Mindless Money 4/5: Stay Resilient, Be Prepared”

  1. Anonymous says:

    Shaun, what do you mean ‘IMF is no longer the organisation it used to be’? Was IMF really successful before?

    Slovenia is in Euro.

    You have advocated in other countries to leave Euro. In Greece and Cyprus people clearly believe that the penalty for exit is too high (clearly higher than the ‘rescue’ as there are geopolitical issues; furthermore, there are many doubts that exit will solve economic problems; there are countries outside Euro that are in austerity programs and far worse).

    What about Slovenia? Slovexit?

    1. Anonymous says:

      Hi Vassilis,

      The IMF successfully extracted Bulgaria from hyperinflation in 1997.

      1. Anonymous says:

        I dare say that this is not that impressive to me.

        1. Anonymous says:

          Fair enough. The old strategy of default, devaluation and balanced spending does bring recovery.

          The alternate IMF strategy used in Greece & Portugal appears to bring only misery and further economic decline. Could French bank exposure and French managers at the IMF affect the IMF policies ?

          1. Anonymous says:

            Was ‘default and devaluation’ IMF’s strategy and it is not now? It might have been, I don’t know, but Argentina did not default I think in this way. Could US interests and US managers affected and affect the IMF policies? I think yes.

    2. Anonymous says:

      Hi Vassilis
      My argument goes back to a theme I have established on the posts I have written on the IMF. It used to be an organisation which mostly helped with trade deficits and had a reasonable success rate at so doing for example my country the UK in 1976. However it has morphed into one which mostly bails out fiscal deficits and so far has a shocking success rate at so doing.
      In essence it has been taken over by the political class who have made it a vehicle for backing up politicans spending problems…
      If we look at Greece in “old thinking” then the squeeze would have been less severe and she would have defaulted and devalued too, so she would in my view be in a much better place than now. There would probably be something of a recovery going on instead of the current sad morass.

  2. Justathought says:

    Oh! Come on Shaun you are more than clever to know what must be done. Unfortunately until they persist with their Eurozone nightmare we are stuck in this bottomless pit…for how long? The last five AAA countries cannot support more than they have done. Look at the Netherlands spiralling into hell…

    1. Anonymous says:

      Hi Justathought
      I have been writing about the economic decline of the Netherlands for some months now and it is nice to see the Economist (at Easter) and now Der Speigel catching up!
      As to Slovenia I was purely considering the conventional bailouts from the Euro and the modern-day IMF and I don’t think they would help much if at all. Although Slovenia may yet be forced to take the poisoned chalice.
      As to the Euro the issue is less clear cut as Slovenia has a trade surpus so there is no urgent need to leave. However whilst being in the European Union has gains for her I agree that she may well regret being a member of the Euro as she will have less freedom of action over interest rates and will not have her own exchange rate. Of course should some weaker currencies go the new hard Euro would be ever more like the Deutschemark and would probably force her out.

  3. Anonymous says:

    Hi Shaun,

    The construction sector has had a wild ride, in 2006 sales were flooding faster than property could be built – some off plan projects with several year timescales. By 2009 the buyers were struggling to make payments and a significant proportion were defaulting. This impacts on cash flow disastrously – money counted on and required to finish half sold projects is not coming in. No surprise that the big heavily leveraged construction firms are under water. The banks calculated that the unsold apartments were good collateral, but savage falls in value and asset flight have given the banks massive bad debt problems.

    A few years ago I went to look at some MGM alpine properties being built in Les Arcs & Les Menuires with incredibly high price tags. I’m wondering what construction exposure the French banks have ?

    1. Anonymous says:

      Hi Expat

      “The banks calculated that the unsold apartments were good collateral,” How familiar is that phrase becoming in this crisis?
      You make an interesting point about the French banks. I fear the worst as they have been accident prone to say the least….

  4. max says:

    keep up the good work Shaun.

    As usual with all these problems the answer is something like..’if I was going there, i wouldn’t start from here’.

    I hope that, in our human evolution, some lessons are learned from the disaster that has been deregulation of credit and Fractional Reserve Banking.

  5. MajorFrustration says:

    Looks like another depositor haircut on the way

    1. forbin says:

      damm , is there still time to get your money out and under the mattress ?

      may time to buy popcorn ?


  6. Anonymous says:

    Shaun – a fine analysis again. You mentioned the motorway building programme. A vast number of kilometers were built, designed I believe to link the (colder) north of Europe to the (warmer) south. Hence the old joke from Croatia that “Slovenia is the parking lot for Austria”. A bit harsh but so much money was sunk into this exercise – and it does make the holiday journey a much better experience. I note this morning that Slovenia has unanimously agreed to Croatian entry into the EU from 1 July. Another domino waiting to fall?

    1. Anonymous says:

      Hi Ray
      I am told it is a lovely country and replied by saying that by car you can get around it more quickly now! Do they follow the European model and charge tolls on these roads?
      As to Croatia I can only conclude that its political class sees jobs and influence for themselves as the potential gains from the Euro have turned into problems.

      1. Anonymous says:

        Hi Shaun – yes it’s a beautiful country especially around the Lake Bled area. Major motorways are now toll-roads but the scale of charges is not that of the French autoroutes (yet!!)

        1. Anonymous says:

          Hi Ray,

          Do they still use the Vignette system ? I’ve seen a new motorway section near Trebnje (Ljubljana-Zagreb road).

          1. Anonymous says:

            Hi Expat – as far as I know they do have a vignette system but quite expensive. This causes all sorts of problems for holiday-makers going to Croatia by car from Austria and Germany, but I believe other parts of the system have the normal table of fees – always subject to “revision”.

          2. Anonymous says:

            Better vignettes than tolled autoroutes a la France & Italy.

  7. forbin says:

    Shhh everyone !

    the Iceland solution is going to be great for Slovenia!

    will they choose in time ?

    pfft ! not a chance , this Euro Project promises gold to the top Politicos – they know which side their bread is buttered, nowt to do with the good of the people.

    It does pose the question , when will the German people realize they will be the only ones paying to run this show?

    can they get out in time ?

    do they really want to pay for another “East Germany ” ?

    actually can they afford too ?

    time will tell – theres precious little left

    pass the pop corn – its going to be a interesting year!


    1. Anonymous says:

      Hi Forbin
      More than just a year I think…

  8. Anonymous says:

    “as you see any year plus one is always bright!” – Just wondering: Has any central bank or similar authority ever forecast a decline after the year ahead?

  9. Paulo Garrido says:

    I think the best solution at this time is to restructure the Eurosystem from a single currency system named Euro to a multi-currency system. The currencies in this restructured currency system would comprise the Euro of course and the Euronationals, named Euro-NewDenominationOfNationalCurrency.
    The Euronationals should be full sovereign national currencies. This way the ECB could decouple its future from the single currency concept and going on working as the EZ international settlements bank, the provider of the Eurosytem of currencies Together with making other useful things as managing the required process of planned Euro denominated debt reduction to safe levels.
    The prospects of economic recovery given by governments being able to adjust net government spending (most known as national public deficit) to the requirements of national economies and Euro denominated debt reduction, EDRR, should avert recession and deflation immediately after being recognized, restoring monetized economic growth and development.
    The principle to apply in EDRR is that international real debt is to be paid through exports, not asset sales. This requires the creditor countries in and out the Eurozone to become net importers from debtor countries, either directly or indirectly. And these having liabilities denominated in Euros would be required to take care of their Euronationals exchange rate, in case of having switched to.
    There are several scenarios. The general principle would keep the positive aspects of the single currency experiment then avoiding their loss by the current steering to implode the Eurosystem by trying to maintain it as a single currency system. And would restore the resilience of sovereign national currencies together with many improvements both in the ‘North’ and the ‘South’.

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