Since the depths of the Great Recession, the market has been on an incredible tear…
The chart above shows the Vanguard Total Stock Market ETF (VTI). It represents nearly 100% of the investable domestic equity market.
If you owned VTI—or a simple S&P 500 index fund—over the last decade, you would’ve more than quintupled your money.
Unfortunately, the average investor hasn’t enjoyed this ride. As you can see below, he’s done worse than everything else…
So why is the average investor doing so badly when the market is reaching new all-time highs?
You see, the emotional roller coaster ride shakes many investors out of the market. They buy at tops and sell at bottoms…
But if you simply stay the course, you’d avoid these mistakes. Look, we understand. Investing isn’t easy.
People jump in and out of investments based on headlines. And they get whipsawed by market volatility.
But as a Daily reader, you aren’t the average investor.
You see, we have a plan. And that’s why we’re crushing the market…
In the first half of 2019, the S&P 500 was up 18.5%—the best six-month start for stocks since 1997. But our portfolio in The Palm Beach Letter was up 23.8% over that same span. So we outperformed the broad market by 29%—with around 60% less volatility, too.
And in today’s essay, I’ll share our five-step plan to keep you grounded even through the most volatile of markets…
Five Rules to Stay Rational
We’re in the longest bull market in U.S. history. But you won’t benefit unless you stay in stocks.
Now, the best way to do that is to avoid the emotional roller coaster. And these five rules will help you make more rational investing decisions…
- Diversify your assets.
The secret to building wealth—and keeping it—is diversification. That’s why we publish an asset allocation guide each January. It’s our most important issue of the year. (PBL subscribers can read our 2019 guide here.)
We recommend a mix of domestic and foreign equities, large-cap and small-cap stocks, bonds, cash, commodities, real estate, collectibles, cryptos, and other alternatives.
Not only does diversification lead to better returns, it also lowers risk. Numerous studies show that asset allocation accounts for 90%-plus of your investment returns.
- Tune out short-term forecasts.
The market’s short-term direction is unknowable. No one has a crystal ball. Even experts get it wrong more often than right.
Take the ongoing trade war between China and the U.S., for example. Last week, editor Teeka Tiwari called the negative stories noise:
I’m seeing investors drive themselves crazy trying to figure out what every headline means for the market. And I want you to understand that most things in the market are unknowable.
So instead, I focus on underlying trends rather than day-to-day headline nonsense.
As long as the overall price trend is up, I stay in stocks and ignore the news.
Like Teeka said, unless you’re a day trader, daily volatility shouldn’t bother you. So don’t get sidetracked by the noise. Just focus on the big picture.
- Have a risk management plan.
Before you can grow wealth, you need to protect what you have first. The best way to do that is with position sizing.
Position sizing refers to the size of a position within your portfolio (or the dollar amount you’re going to trade). Our simple rule of thumb is: If an investment gets stopped out of your portfolio, your maximum loss should be no more than 2.5–5% of your portfolio’s value.
If you know your downside is capped, then you can sleep easily at night. This way, you won’t panic-sell at the worst time.
- Use systematic investing.
Systematic investing simply means investing money regularly. Sign up for direct deposit in a taxable brokerage account.
Take advantage of a retirement plan where you can allocate part of your paycheck to investments (and maybe even get an employer match). And switch your mutual funds, ETFs, and dividend-paying stocks to dividend reinvestments if you don’t need the income.
- Create a plan and stick to it.
Other than annual adjustments and periodic rebalancing, you shouldn’t deviate much from your investing plan. If you have a life-changing event, revaluate your plan at that time. But sticking to a plan will keep you from investing based on emotions.
If you implement these rules, you’ll be able to ride the stock market to new highs without getting shaken out during times of volatility.
And you’ll perform much better than the average investor.
Analyst, Palm Beach Daily
P.S. What’s your key to avoiding the emotional rollercoaster and staying invested? Let us know right here.