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investing

Keep Your Shields Up When Navigating the Investment Space

All the turbulence in the markets now is serving as a valuable wake-up call: Investors need to be ready to deflect those stock shock waves. Here's how to do that.

Remember the Star Trek episodes of years past? Whenever the Starship Enterprise was under attack, Capt. Kirk would shout something like, “Shields up! Red alert!” The crew would then spring into action just before entering the danger zone.

This got me thinking about the recent market volatility and wondering what average everyday investors can do to protect themselves and activate their own personal “shield,” if you will. In my opinion, this “shield of protection” is created way before you experience a drastic decline in the markets like we saw in October and again in December of 2018.

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Most of us, cognitively, know the basic rules of investing, such as building a diversified portfolio, staying disciplined long term, rebalancing back to targets and above all, not panicking. However, market data show in the midst of major volatility, average investors typically break these rules and initiate a huge wealth transfer to the other side.

There is always someone on the other side of the trade. If you’re in panic mode, frantically hitting the “sell” button, there is someone on the other side of the trade hitting the “buy” button, profiting from your panic.

How to get an investment shield in place

Putting up your shield starts with developing an investment philosophy so strong that when the tough times come (which is completely normal and expected), you will instinctually activate your proverbial shield, fall back on this strongly held core philosophy and breeze through to the other side.

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So what does it take to develop this core investment philosophy? Try these three simple steps:

1. Develop your true purpose “value” statement.

I describe this to clients as the most important value in your life that you express through your use of money. This is much more than writing down your financial goals in life, although goals are extremely important. If a goal can be described as a “destination” you want to achieve financially, the value can be described as the “motivation” for why you want to achieve that goal. For example, if your goal is to buy a second home in a warmer climate in retirement, your motivation to achieve that goal may be a core value for you such as adventure, freedom or health.

2. Develop a belief about how the market works.

This comes down to two simple choices. Choice 1, adopt “The Markets Work” belief that the market is efficient and all known information is already priced in. Only new and unknown information will change the direction of the market or an individual stock. Choice 2 is “The Markets Fail” belief that the market often gets it wrong, and with the proper information or research that no one else has (yeah, right!), you can take advantage of mispricing, unrelated to risk. In case you couldn’t tell, I tend to believe Choice 1 is the better way to go. We’ll get more into why in a bit.

3. Develop an investment strategy that is in alignment with your market belief.

Your choice in step No. 2 will guide which strategy to employ when investing your money.

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For example, the idea that “The Markets Work” and cannot be predicted or forecast goes hand in hand with the passive strategy of asset class investing, which is designed to expose the portfolio to multiple types of investments, including equities and fixed income, domestic and international markets, growth and value equities, as well as large-cap and small-cap equities. The goal is to provide maximum diversification to minimize risk while maximizing returns.

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If you think markets work efficiently, then buying and selling securities in an attempt to outperform the market is effectively viewed as a game of chance rather than skill.

The opposite is true for “The Markets Fail” approach, which assumes the markets can be forecast and predicted, and therefore employs an active-management approach by stock picking and market timing. I believe that all knowable and predictable information is already factored into the market, making it virtually impossible to consistently predict market movements and capture additional returns. After all, if these active managers really could predict the market or pick the best stocks, would they really share that information with you?

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When you believe the market cannot be forecast or predicted and employ an investment strategy that is in alignment with that belief, you have created a powerful shield. On the other hand, if you believe that markets fail, then you might find yourself without a shield, exposed to the risk associated with speculating and gambling rather than prudently investing your money.

Watch out for these market threats

When it’s time to shout “shields up!” what threats are we really protecting ourselves from? We mentioned market volatility is normal and can even be desired; after all, that’s where long-term returns typically come from. But what about other threats, such as our own perceptions, instincts and emotions that lead to harmful investment decisions? That’s where the people who believe that markets can be forecast and that information available only to a select few — like Bernie Madoff — can be leveraged to their benefit can be vulnerable.

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We all hear the horror stories of investors being taken advantage of by the Bernie Madoffs of the world, the outright con men who steal people’s money. But what about believing the latest stock-picking hedge-fund guru or market forecaster on television every night? They surely must have all the answers!

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And what about the social media messages and emails we receive promising great investment returns with little or no risk? I’m sure you’ve received a few of those during your investing journey. Think of these messages as little “misinformation missiles” being launched at you all day, every day. Dodge those missiles, and instead, stick to your solid investment plan.

What the right investment philosophy will do for you

With your newly developed investment philosophy — based on the idea that markets work and relying on asset class investing to keep you on track — you may:

  • No longer see market volatility as harmful but rather an opportunity to rebalance back to your target asset allocation.
  • No longer fall for the “con man” schemes because you know where returns come from and how markets work.
  • No longer mistake luck for skill because you now employ asset class investing rather than active management, such as stock picking.
  • No longer respond to the fraudulent emails or social media messages promising lofty returns because you now know there is no free lunch when it comes to investing.

What a great way to live your life, knowing you will make it through the difficult times rather than a mindset of scarcity and concern of running out of money. I know which way I want to live my life. How about you?

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About the Author

Jeffrey D. Montgomery, Investment Adviser Representative

Founder and President, Montgomery Financial Services

Jeffrey D. Montgomery is the founder and president of Montgomery Financial Services LLC (www.mfswealth.com). He works primarily with pre-retirees, retirees and affluent small-business owners, helping them grow, protect and distribute their financial assets.

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