At Berkshire Hathaway’s 2018 annual meeting, Charlie Munger gave his partner Warren Buffett, a backhanded compliment that drew a roar of laughter from the crowd: “Part of Berkshire’s secret is when there’s nothing to do, Warren is very good at doing nothing.”
It was a well-timed joke but also a critical piece of investing wisdom from Munger, who passed away on November 29th. It’s one that helped make the reputations of Buffett and Munger as the world’s greatest investors.
Successful investors take a relentlessly patient approach to managing their money. Once they have a solid financial plan in place, their default position is to do nothing in the face of troubling economic and political events and market volatility.
The last three months have provided a real-time example of why this approach is so important for building your wealth. September and October were dismal. The U.S. stock market declined 4.9% and the Canadian market was down 6.4% during those months.
Pundits had many explanations for the poor performance. Was it growing fears of recession? Inflation not coming down fast enough? Global instability caused by conflicts in the Ukraine and the Middle East?
If you did nothing in response to any or all these worries, you made the right decision because the stock market bounced back strongly in November, with the U.S. market gaining 6.8% and the Canadian market 7.5%.
Now that things are back on a more even keel (at least for the time being), it’s a good time to check your emotional reactions to this fall’s stock market gyrations.
Perhaps, you weren’t even aware of them. If so, bravo! However, the reality is that many people follow the ups and downs of the market and fret about how bad things could get during a pullback. Those concerns quickly melt away when the market moves higher to the point where they often have difficulty even remembering what had happened a few short weeks earlier.
That’s an example of a cognitive bias known as loss aversion. It occurs when investors experience greater pain from losses than pleasure from gains and it’s a powerful force that’s not always easy to control if you’re not Warren Buffet or Charlie Munger.
Indeed, some people are so troubled by a sharp decline in the market they feel compelled to take action, often persuading themselves that what they’re doing is perfectly rational. That’s when wealth destroying errors are made.
It’s essential to recall there will always be economic and geopolitical uncertainties and problems, but also positive developments. In the case of the November stock market rally, it now seems clear the impetus was signals from central banks, led by the U.S. Federal Reserve, that they are done raising interest rates and are closer to lowering them.
While this underlines the importance of interest rate trends in moving capital markets, it was only evident in hindsight. The positive change in investor sentiment was no more predictable than the negative one that drove losses in the two previous months.
That’s why we hold broadly diversified, passively managed portfolios. We take the returns that the markets offer us. It’s an approach that Buffett recommends for ordinary investors who aren’t geniuses like him and why he made this observation: “The stock market is designed to transfer money from the active to the patient.”
Stock market history teaches us that if you can keep your head in the storm, you will reap the rewards when the clouds clear.
Source: Dimensional