What would you if your portfolio went down 50%?
Since the mid 1960s, Warren Buffett has been CEO of Berkshire Hathaway. Under the direction of Warren and his right-hand man, Charlie Munger, the company has increased at an average rate of 20% PA, compared to about 10% PA from the S&P 500 index with dividends included over the same period, while employing large amounts of capital and minimal debt.
Berkshire is the seventh largest component of the S&P 500 index and the top-ranked company in the Forbes Global 2000, which takes into account both market value and fundamental data.
It would be hard for anyone to say Berkshire is not a great stock to hold. If you started working in 1980, investing modestly in Berkshire on a regular basis, and retired in 2020 you’d certainly be set to enjoy a comfortable retirement.
However, at least twice in its history Berkshire Hathaway stock has dropped more than 50% in value…
Many of us, perhaps the majority, would find it very, very difficult to watch our valuations drop 50% and go back to life and ignore it. This is why many aspects of investing are psychological, not technical.
Our rational minds can accept that stocks drop, sometimes heavily and take time to recover and move up again. Rationally we know that we shouldn’t have less than a five or ten-year time horizon with our stock-based investments and that the evidence points to long-term investors winning out. Rationality is wonderful but it doesn’t pump a huge dose of thought-changing hormones into our bodies when presented with short-term bad news, that can cause us to think and act differently.
And it’s in that instant rush of hormones that we can make decisions which cost us dearly if we’re not able to manage it.
Over the years I have seen people panic sell and thus crystalise a dip, at far less than 50%. Some begin to get uncomfortable when they see things drop 5% let alone 50%.
When I first started in the industry many advisors were told by their companies to switch client funds regularly during times of volatility - this usually resulted in lower returns for clients. It’s still something I see happening today which surprises me as the body of evidence supports buy-and-hold strategies for 90% of people.
Whether you’re a seasoned investor or just starting your investment journey, it’s important to be mindful of your own psychology so you can avoid situations where you find yourself exiting a position at a loss.
For some of us, it may be better to look at alternatives to stocks and funds for the bulk of our investing if that means being able to sleep better at night because ultimately we should be investing to create peace of mind for the future - rather than add worry while we are on the road to financial security and freedom.
So what would you do if your portfolio dropped 50%? Let me know - the answer might help you find more peace of mind while you work towards your own goals.
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