Updated: Aug 4
Take an investing long view - make time your investing friend! We use our Investing Barbell Strategy as a proven approach to managing our finances. But, did you know that only about half of U.S. households own any stock either directly or indirectly via mutual funds or pension funds? [i] Wow.
About the author: Jeff Hulett is a career banker, data scientist, and choice architect. Jeff has held banking and consulting leadership roles at Wells Fargo, Citibank, KPMG, and IBM. Today, Jeff is an executive with the Definitive Companies. He teaches personal finance at James Madison University and provides personal finance seminars. His new book -- Making Choice, Making Money: Your Guide to Making Confident Financial Decisions --will be published in Summer 2023. You may register for pre-order information at jeffhulett.com.
The following graphic shows the incredible difference in U.S. wealth groups. All people can save. Moving to the right on this distribution means growing your wealth. Growing wealth takes time. Saving TODAY is the first step toward building wealth in the future. If you are already in the top 1% of wealthy Americans, congratulations! But this article is not for you. This article is for the remaining 99% of us!
Both personal finance experts and economists agree that better financial outcomes occur when people invest in the financial markets. [ii] A challenging reality is, the path to better wealth outcomes via the financial markets is marked with ups and downs. This article begins by discussing the difference between an investor and a trader. The investor's mindset is essential to financial success. Then, we discuss the "zoom-out" investment approach to further enhance the investor's tool set. Finally, we present the spring investing analogy to describe the impact of investing during contacting economic environments. If you have an interest in exploring how to save, including a helpful saving mindset, please see our companion article: Budgeting like a stoic.
Table of contents
The difference between an investor and a trader
Zoom-out is a winning investor's mindset
SPRING investing is the investor's tool
1. The difference between an investor and a trader
What is the difference between an investor and a trader? It has everything to do with time horizon and market alignment.
Trader → Short focus → For bull markets, time is more likely to be a trader's friend. For bear markets, time is more likely to be a trader's foe.
Investor → Long focus → For bull markets, time is more likely to be an investor's friend. For bear markets, time may be an even bigger friend.
A trader's life
As a trader, it is easier to make money in a bull market. A rising tide raises all ships. Certainly, not every long trade provides a positive return over a short horizon, it is just more likely when the market is increasing. Plus it is possible to "move the goalpost." This occurs by changing the definition of the short time horizon and realizing a positive return over an extended time period. In a bear market, deploying short or put-based strategies is a standard approach to earning trading revenue. These are strategies that earn income when the underlying security goes down in value. Bear market strategies are more challenging. Time is working against you. Moving the goalpost is generally not an option.
Down market strategies are generally time-boxed. Not only do you need to know whether a company will go down in value, but you must also know when it will go down in value.
Typical option expiration calendar. The traders must accurately predict the direction and timing of the market.
Time is fickle. Many predict an eventual downturn correctly. Getting the timing right is the challenge. Next is an on-point aphorism, sometimes attributed to legendary economist John Maynard Keynes:
“The market can stay irrational longer than you can stay solvent.”
This timing is often based on predicting the psychology of the market. Traders with long profits will resist selling until there is a "rush to the door." Then, with sufficient momentum, the market will quickly move. Will that occur this month, next month, in a year, or never? When the market does move, are you able to anticipate the move? It is very challenging to know and act upon “when.” Next is a story about one of the biggest bear market short trades in history. This story demonstrates the challenge to pull off a successful short.
The Big Short. Was Dr. Burry lucky or good?
Dr. Michael Burry is the hero of the Michael Lewis book, The Big Short. The book is based on a true story. It was also made into a movie of the same name. Dr. Burry created one of the boldest short strategies in history. He shorted the U.S. housing market and mortgage bond market during the hay day of the U.S. housing market. The signs of an imminent correction were clear. He and a small number of other enlightened investors talked to market makers, mortgage investors, bond rating agencies, housing investors, mortgage originators, and even home-flipping strippers. All indications were that the U.S. housing market was ridiculously overvalued. Dr. Burry was confident the housing market would correct. He just did not know when.
So Dr. Burry and his hedge fund implemented their short strategy. They waited. They waited. Nothing happened. Home and bond values continued to go up! His hedge fund was being hounded to provide additional capital against their trade. Capital calls are standard when the market moves against a short trade. This "big short" trade initially declined in value owing to the stubborn home market value increases. Dr. Burry’s investors were SCREAMING for him to exit the short trade. He was threatened with lawsuits. Dr. Burry almost had a mental breakdown. But he held on. Then it happened. The U.S. bond and housing markets FINALLY corrected. It was one of the largest financial corrections in history. Dr. Burry and his investors were richly rewarded. But Burry was lucky. Most others, whether on the short or long side of the housing trade, ended up with a financial fiasco.
That is why bear market trading is so challenging. In fact, legendary investor Warren Buffett said:
“Only when the tide goes out do you discover who's been swimming naked.”
He was suggesting those with suspect trading strategies will be revealed in bear markets.
The investor's mindset
The intrinsic purpose of a company is to create value. In the long-run, higher profits are an outcome of a job well done! Higher profits are like a “yes” vote from happy customers that received that value. Investors reward the customer's “yes” vote with “yes” votes of their own. Long-term shareholder value increases as companies increase value. As such, long-term investors are aligned with the companies that make up the market. In the main, the “yes” votes are revealed in the long term. All companies can have bad quarters. The long-term is revealed over many years or decades. Also, not all companies are successful. Since company prospects may change over time, the long-term is revealed in the context of a balanced portfolio of companies. In terms of rules and practices:
The market is geared toward rewarding long-term investors.
The market is geared toward separating short-term traders from their money.
Successful investors understand this alignment. Investors adapt their investment strategies to this long-term reality. This investor versus trader mentality tends to attract certain kinds of people.
In the remainder of this article, we discuss how to make down markets an investor's friend.
Zoom-out is a winning investor's mindset
Markets have volatility. Sometimes they are more up than down. But at some point in the future, markets will move more down than up. As an example, in 2022, equity markets were certainly more down than up.
The S&P 500 from 2018 to October 2022. This demonstrates a greater than 24% index drop in 2022.
After a nice run in the decade prior, 2022 dropped in the broader market for equities like those found in the S&P 500. Earlier, it was mentioned only about half of Americans do not invest. The reasons will vary, but a significant factor is that investment environments like in 2022 scare the living daylights out of many people! It is both challenging and super important to manage your emotions in a time like this. Your investment staying power is being put to the supreme test! Richard Thaler is a University of Chicago Economist and Nobel Laureate. When it comes to managing your emotions and investing staying power, Dr. Thaler observes:
There is growing evidence that most people would be better off not paying attention to the ebbs and flows of the stock market.”
The question then becomes, how do we manage our fear of uncertainty in a volatile and downward-trending market? To this end:
The long-term winning investment strategy is to ZOOM OUT!
Zoom-out investing means that taking a short-term price performance view of a well-diversified portfolio is a really bad idea. Next, we describe this perspective by first taking the inappropriate "zoomed-in" view. Let's take a "zoomed-in" view of one of the worst financial episodes in modern history, the great financial crisis near the end of 2008. We use 2008 to test the zoom out investment approach. If it worked in 2008, it should work any time.
This chart shows an almost 40% drop in 3 months during the darkest hours of the crisis! This is certainly an ugly view of the market. But it is also an entirely too narrow perspective on the strength of U.S. and global businesses.
Zoom In: The S&P 500 from September 1 to December 1, 2008. This demonstrates an almost 40% drop during the "dark days" of the Financial Crisis.
Next, let's take the zoomed-out view over a decade. This is a more reasonable view based on most people's LONG-TERM needs such as retirement. Remember, financial security and resilience are built over decades, not months. This view is INCLUSIVE of the dark days of the financial crisis.
Zoom Out: The S&P 500 for the decade beginning September 2008. This demonstrates an over 120% gain including and after the Financial Crisis.
In this "zoomed-out" view, a commonly available, well-balanced portfolio like the S&P 500, would have returned over 120% during this time. At the same time, if you had of been out of the market 10 years after the financial crisis, bank savings rates were extremely low. Over the same 10 year period, using the average bank money market rates from the FDIC, the 'scared out' money would have only returned 2.7%. Imagine if you had been out of the market after the financial crisis started. You would have missed a significant decade-long wealth-building opportunity!
In our personal finance journey, we show you how to "Zoom Out" with convenient, easy-to-use tools. Most important, this is all about managing your own psychology. I get it, it is tough watching your stock portfolio go down. The answer is - as Dr. Thaler suggests - then don't watch your portfolio day to day! - ZOOM OUT!
SPRING investing is the investor's tool
Next, let me tell you a story. This story is the setup for spring investing.
Buying a new car
Buying something new is a normal part of life. We also want to be confident we are getting a good deal, especially when making a significant purchase. Let's say you need a new car. Your old car is getting on in years. You know it is one more big mechanic's bill away from costing more than it is worth. You have some time to consider your car options. You look on car websites and find the year, make, and model car you want. Whether you want a new or used car is not important to our story. The point is, through the process of clearly defining and weighing your preferences, you have found several cars that work. Now you wait. A few months later, one of the cars you are interested in goes on sale! It is now 25% less expensive than all the other cars. You are excited! You are so glad you waited. You go and purchase this car at a healthy discount. You feel good. You feel confident. You feel successful!
Yea! The point is, you should feel EXACTLY the same way when investing in down markets. If share prices go down by 25%, you should feel GREAT about buying more at this healthy discount. Unfortunately, many people feel scared. 50% of people will not even invest any money. Many others get scared out of equity markets at exactly the wrong time. It is natural, but it is wrong.
When markets go down, it improves your opportunity to buy balanced equity portfolios at a lower price. The notion is to average down your portfolio basis using a time-tested technique known as "dollar cost averaging."
Think of this like a spring. When you compress a strong spring, you are trapping energy in its coils. Once released, it will give incredible momentum to anything on top of the spring. The U.S. and global economy IS A STRONG SPRING. Thus, load up your compressing investment spring with a well-balanced equity portfolio. Once the market bottoms and the spring is released, then watch your investments fly!
To learn more about our proven, long-term success investment strategy, please see:
[i] Guiso, Sodini, Household Finance: An Emerging Field, Handbook of the Economics of Finance, Volume 2, Part B, Pages 1397-1532, 2013
[ii] Choi, Popular Personal Financial Advice Versus the Professors, NBER Working Paper No. w30395, 2022
We provide several S&P 500 time series price and volume charts from the commonly available Yahoo Finance: https://finance.yahoo.com/quote/%5EGSPC/