Are You an Amateur or a Pro?
Editor's note: On May 17, 2017, the benchmark S&P 500 Index fell nearly 2%.
Our inboxes flooded with readers asking us if the market was crashing and it was time to sell.
As always, we told readers to stay calm. And as you can see in the following chart, May's pullback was barely a blip on the radar...
Chances are good that by now, you don't even remember that day. (In fact, stocks have only fallen 1% or more in two other trading sessions since then.)
But if you were one of the people who was panicked, today's Masters Series essay is for you. Originally published in the Digest on May 19, 2017 – two days after the "scary pullback" – Porter explains why most folks are likely to be wiped out when the next bear market arrives... and how to avoid being a victim...
Are You an Amateur or a Pro?
Did you panic? Were you afraid?
Stocks got beat up on Wednesday, May 17. After starting the week at new highs (around 2,400 on the S&P 500 Index), stocks fell about 2% by midweek, with most of the volatility on Wednesday.
Anytime investors are reminded that stocks can go down as well as up in value, our mailbag "lights up." Subscribers suddenly want to have constant contact with us. They need reassurance. They suddenly can't remember how to use TradeStops because the green, yellow, and red code isn't as clear as buy, hold, and sell. (Yes, those are real comments.)
Friends... If that market action bothered you in any way, there's a huge problem with your portfolio.
Think honestly. When you first saw how the market was going to open (way down), what was your first reaction? Or, if you didn't see the open, what happened when you first saw the news? Or during the day when stocks just kept going down, lower and lower?
Be honest with yourself. If there was even a twinge of fear, you've got a big problem. Let me explain why...
That day saw about three weeks' worth of market gains wiped out, temporarily. It was a tiny, 2% move lower. It wasn't a bump in the road. It was barely a ripple on the calmest lake the equity markets have ever seen.
Since 2015, stocks have been ripping higher, propelled by "rocket fuel" – central banks, sovereign wealth funds, corporate buybacks, and value-ignoring index-fund investors. There's hardly been a down day in nearly two years. This incredible rally has created record levels of investor complacency (aka investor stupidity).
It has also, almost surely, lulled many of our subscribers into portfolio allocation decisions that are far too aggressive.
On the golf course, virtually every amateur player overestimates how far he can hit the golf ball, usually by 20% or more.
Why? Because our best-ever shot becomes our expected outcome.
As we're sitting there on the tee box, we're thinking "I crushed the ball the last time I played this hole. I'm sure I can do it again." Instead of making a conservative swing on the ball – a swing we can hit well nine out of 10 times – we end up taking the big cut... the move that almost never works.
Pro golfers don't make this mistake. They study the distance of every club in the bag, based on their most repeatable swing. They know their distances down to the precise yard. And they don't try to make swings they can't repeat virtually every single time.
Amateur investors make the same kind of mistake as amateur golfers.
They vastly overestimate the expected outcome of their investments. Think about this the next time you buy a stock. Write down what you're expecting to make (annualized) from the investment. Now go and look at what your actual annualized returns have been from similar investments.
The odds are you're overestimating your expected returns by at least 100% – meaning, you're expecting to make twice as much as history suggests you will.
You're probably doing the same thing right now in your portfolio: You're holding positions because you're sure they're going to soar.
Meanwhile, it's unlikely stocks will produce the sort of returns you're expecting...
With stocks trading at near record valuations, with GDP growth below 3%, with consumer debt crashing, and with extremely low interest rates, it's unlikely stocks will produce double-digit annualized returns in the time frame you're planning for. Very unlikely. Virtually impossible.
But every time you buy a stock, I'm sure you expect to make more than 20% over the next year. Or maybe even in the next quarter.
That's because, like an amateur golfer, you're thinking of that great "shot" you hit back in 2015 – that stock you bought two years ago that's soared with the market.
But that's not what's going to happen this time.
That Wednesday was a warning from the stock market "volcano."
It was just a minor rumble. A tiny taste of what will happen when there's another bear market, a decline that's 10 times worse. (A bear market is a decline of more than 20% on the major indexes.)
If you were worried that Wednesday, you'll be crushed – wiped out – by a bear market.
I know... you say you will follow your trailing stops. Or, you say you will just hold on "no matter what." But almost everyone who sets out to be a "buy-and-hold" investor ends up becoming a "buy-and-fold" investor. Just as you overestimate your expected returns, you're also overestimating your risk tolerance.
If you'd asked investors back in 2009 about their risk tolerance, they all would have said "none." They would have told you, "I'm tired of stocks. I only want safe investments. Just give me something that's safe..."
Today, you hear exactly the opposite. At conferences, I'm constantly seeing subscribers telling people, "I'm an accredited investor. I can handle the risks."
But they can't. Not really. Almost no one can.
Here's the best way to think about the risks you're taking...
If you're 100% invested (long stocks) it's only a matter of time before you suffer a 50% drawdown – at a minimum. Warren Buffett, the world's best long-only investor, has seen the value of his equity holdings drop by 50% three times in his career. And it has happened twice since 1999.
You probably aren't as good of an investor as Warren Buffett. It's likely that your results won't be as good as his have been... which means that if you are a long-only investor you will (not might) suffer more than a 50% decline in the value of your equity portfolio.
If you're using trailing stops, you can greatly limit this volatility.
And that's why I endorse TradeStops so strongly. (To be fair, I'm also a part owner of the company. But I invested in it because I share in Richard Smith's mission... to give individual investors the best possible tools to help them become more successful investors.)
In fact, if you merely use a trailing stop loss and reasonable position sizes, I can almost guarantee that your investment results will become dramatically better.
Regards,
Porter Stansberry
Editor's note: Dr. Richard Smith's TradeStops software can tell you exactly how many shares to buy. It has a "one click" calculator that can immediately optimize your portfolio to take advantage of the "Melt Up," while protecting you from any market pullback. TradeStops can also show you the hidden levels of risk in your portfolio... rebalance your portfolio for you... and eliminate all of the guesswork and emotions when it comes to investing.
And until Monday, Richard has agreed to give all Stansberry Research readers a gift worth up to $1,000, just for signing up. Don't delay... Get started here.