We as humans are not as rational as we think. We succumb to a lot of behavioral biases, courtesy, our evolutionary roots.
Unfortunately, these biases mess up big time with our investment decisions.
We BUY HIGH and SELL LOW instead of BUYING LOW and SELLING HIGH.
Now, let me be brutally frank with you.
This is something that by now, almost everyone of us knows. This whole “humans are irrational” theme has been beaten to death.
The simple retort is:
Hey, I completely get it, that I behave irrationally a lot of times. But what do I really do about it?
This is exactly what this post will attempt to answer. Instead of blaming you and me for our irrational behavior, we will rather try and workaround a behavioral solution to counter the biases.
Now since there are too many behavioral problems to sort out, we need to be practical and pick our battles.
When it comes to investor behavior, I think two of them are disproportionately important.
- How we behave during a bubble phase
- How we behave during a bear market phase
If we get these two right, we are 90% sorted when it comes to our investments!
Yeah Right! If only it were so easy.
The reality remains that..
We are fearful when others are fearful and greedy when others are greedy!
How do we handle a bear market without panicking?
Now there is a far more basic question which we need to answer before that..
Why in the world is it so difficult to handle a bear market?
Here is a presentation that I had done earlier, on the different behavioral biases which come together during a bear market and make it extremely difficult for us to stay the course
Handling one behavioral bias in itself a pain. When many of these come together, it becomes an incredibly difficult task to make good decisions.
So what do we do about it?
Let us first solve for the easier ones
The first simple task, is to make sure we don’t let sudden, unexpected money requirements force us to sell our equities for liquidity reasons.
1.Get an emergency fund
- Build your 3-6 month spending needs in a liquid fund
This is unbelievably boring advice. I know.
But when suddenly faced with talks of pay cuts, job losses, sudden money requirement etc during a bear market, this will help us – keep calm and carry on with our portfolio.
2.Get next 5 year requirements out of the way
- For goals coming up in the next 5 years, stick to conservative options (with minimal downside risk) such as Ultra Short Term/Short term debt mutual funds or arbitrage funds
Now with near term money requirements out of our way and emergency fund in place, we won’t have to touch the portfolio for near term requirements or emergency needs.
Investing is the age-old, never-ending emotional battle between fear of the future and faith in the future.
Equity investing in the long run finally boils down to your faith in human progress and entrepreneurship. You are simply betting that entrepreneurs (who take higher risks) on an aggregate will get compensated with higher returns.
When a bear market hits, your conviction on Indian entrepreneurship will inevitably be tested.
Suddenly someone from media will show that Japanese equity market has had a 20 year+ bear market chart.
There will be a worrying voice in your head – “What if this one turns out to be similar?”
Only in future will we know the precise answer to this. But the time for you to decide the answer is now when times are good. A bear market is a bad place to find out the answer.
Your conviction and answer will decide your equity allocation.
Personally I believe that India remains a secular long term growth story. As Prashant Jain of HDFC AMC puts it, the secular growth will be driven by
- Excellent demographics and rich natural resources
- Large availability of skilled, young, English speaking and competitive manpower
- Low penetration of consumer goods and improving affordability
- Large unmet needs of infrastructure and strong reforms momentum
So my faith is that, future bear markets will be temporary declines in prices (read as opportunities to buy good businesses at lower prices) and as seen historically in the long run the equity markets will move up and mirror earnings growth.
Without this basic ingredient called faith, it is impossible to stick to the plan during a bear market.
If you think otherwise, then this article might not be of much use to you.
4.Is your portfolio risk aligned to the risk which you can tolerate
Once you are convinced about your faith in Indian equities, the next task is to find out, the emotional fees to be paid to participate in Indian equities. This in investment jargon is called risk.
The risk in your portfolio can be evaluated by the framework here
Based on the extent of short term decline you are willing to tolerate, decide on the asset allocation. Check if the your current asset allocation is aligned to this. Else adjust your asset allocation and align.
To be fair, this topic needs a separate post which I will do in the future. As of now, here are the approximate thumb rules for how to choose appropriate Asset allocation
- 90% Equity + 10% Debt:
- Risk: 25% normal decline + 50% fall in crisis
- Return Expectation: 12-14% – double in 5-6 years
- 70% Equity + 30% Debt:
- Risk: 20% normal decline + 40% fall in crisis
- Return Expectation: 11-12% – double in 6-7 years
- 50% Equity + 50% Debt:
- Risk: 15% normal decline + 30% fall in crisis
- Return Expectation: 10-11% – double in 7-8 years
- 30% Equity + 70% Debt:
- Risk: 5% normal decline + 15% fall in crisis
- Return Expectation: 9-10% – double in 8-9 years
5.Do you have a framework to cut risk in a “bubble” market
When driving a car, there are certain risks that you can’t control.
Minor dents and scratches are a part and parcel of life for us in India. Major accidents due to reasons such as a stray dog suddenly running into your tyres, a drunk guy ramming you from behind, slippery roads etc are also not under our control. BTW all the above are examples which have happened to me 😦
But there are some risks which are under our control such as drinking & driving, talking over the phone while driving, driving late nights when you are sleepy, excessive speed etc.
Similarly in equity markets, there are times when markets enter into a bubble. There are usually signals in terms of parabolic rise in prices, high valuations, strong flows, high earnings growth, excess leverage, euphoric sentiments etc. This is a risk which to a certain extent is in our control and can be managed.
So while all risks cannot be eliminated, it helps to have a framework to evaluate and manage the risks under our control in overall markets and different segments of the market. Do have a word with your advisor and make sure you put one in place. For those on your own, you can refer this post of mine to get a fair sense of how to approach this.
The basic idea is to start cutting risks in the portfolio (via adjusting asset allocation) when we enter a bubble zone.
6) Can you or some expert predict the markets?
When it comes to creating a bear market plan there are two schools of thought
School of Thought 1:
Every bear market is different. I need to manage my portfolio based on my views of the fundamental event that has caused it
This is extremely difficult to pull off in reality. Think about the major events which have hit us in the past – 2000 Dot Com Crisis, 2008 Sub Prime Crisis, 2011 Euro Debt crisis, 2016 China Crisis etc. And add to it other events such as Domestic Elections, Budget, Trump winning, Brexit, Fed Policy, Demonetisation, NBFC crisis etc. To evaluate each and every one of them correctly and predict how millions of investors will react to it, consistently is a tall ask.
Let us listen to what some of the best investing minds have to say about this..
“You have to keep reminding yourself. We don’t know what’s going to happen with anything, ever.” – Peter Bernstein
“There are two kinds of investors, be they large or small: Those who don’t know where the market is headed, and those who don’t know that they don’t know.” – William Bernstein
“After nearly 50 years in this business, I do not know of anybody who has done market timing successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently.” – Jack Bogle
“I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two.” – Warren Buffet
Now if you still think it can be done, all the best!
School of Thought 2:
All bear markets eventually end and markets recover. Equities go up in the long run. All falls are opportunities. So all I need is a systematic process to buy equities when it falls.
I belong to the second school. The plan to increase exposure to equities can be based on price falls, valuation, momentum etc. I leave it to your choice.
The base assumption is that Indian equity markets will track earnings in the long run and will provide far higher returns than inflation.
7.Why is this important?
When market correction starts, there is usually some negative event causing it. Intuitively, your mind will say that the markets will fall further. But you resist the lure. And then the expected happens – the market falls further the next week just as your intuition suggested.
This point in a falling market where your intuition comes right in the short term is the most dangerous phase. You regret of not having listened to your intuition. “If only you had sold earlier”..
You still resist the lure. The market falls yet again the next week. Phew. You were right all along. Maybe you should have listened to your intuition. Your regret gets over you. This time is different. Let me get out now.
When things improve I will get back. You utter the most dangerous words during a bear market.
You have suddenly moved from your original view that “you can’t predict the markets” to “let me evaluate the fundamental event that has caused it and take a call on when to enter back”
Evidence is overwhelming that this approach usually leads to failure in handling a bear market.
This is exactly why, you need to make up your mind on your stance right now. Take your time. Read everything on this. Talk to experienced people. Check if there is anyone who has done it consistently and successfully.
Whatever be the stance, stick to it. This will be the determinant of how we handle the bear market.
8. The Bear Market Plan
With all the above in place, we finally come to our plan.
In a falling market, the biggest trap is trying to take daily decisions based on the evolving events.
When it comes to decision making, less is more and hence we need to reduce the number of decisions to be taken. Most importantly we need to have a clear pre-decided plan on WHEN to take these decisions.
I personally use a 20%-30%-40%-50% decision making trigger and have reduced my decision making points to around 3-4 during a fall.
- If market falls by 20% then I will..
- If market falls by 30% then I will..
- If market falls by 40% then I will..
- If market falls by 50% then I will..
Sounds extremely simple, but trust me, once you start thinking about this, you realize how difficult it is to decide even in normal times.
If you have an advisor this is probably a great time to sit together and chart out a plan. If you don’t have one, then make sure you write down your plan as it’s extremely difficult to think clearly in the middle of a falling market.
Also it serves as a reference to check how you thought you would behave during a fall (in your cool and calm avatar) vs how you actually behaved.
If interested you can read the detailed version here
9. How do you ensure you don’t panic and end up not executing the plan?
So far so good.
Emergency fund – Done
Short Term Goals – Taken Care
Faith in equities – No worries
Asset Allocation – Aligned with my risk tolerance
Framework to Cut risk in Bubble phase – Yup. In place
Bear Market Plan – Planned like a boss!
But all this is still theory. While some plan is still better than no plan, execution is where the trouble starts.
Despite all this preparation, the real experience of witnessing several years of our hard earned money getting wiped off week after week might be a lot more difficult emotionally than we envisaged. Add to it the concerns of our family, plus the “what if I have recklessly gambled away my kids education money” type of hard hitting questions.
This is where we need to take the help of psychology used in other contexts and fields where people take suffering in the short term for long term gains.
10. What are the other fields from where we can derive clues?
I have always been intrigued by the Indian army. How in the world do they motivate and transform young people barely out of college to super heroes who can courageously face bullets, grenades, landmines, enemies, floods, earthquakes etc sometimes even at the cost of their lives. The great part is they have institutionalized this. In fact, this applies to all the armed forces of the world.
What do you think is the reason?
Check this thread (link) in Quora where ex-army men discuss on how they handle fear. Read below a few of the interesting answers
“Accept that you are already dead. None of us are making it back. Don’t be a pussy, don’t bitch out over something that is gonna happen regardless of what you fear.”
“There are aspects to be considered. The most obvious and easiest is to know that you have been well trained, know your job, have knowledge of tactics, weaponry, purpose of mission, trust in your self and your men, and feel confident in those areas.Confidence helps a lot. Also, you know that you are not alone – you have buddies when lives are on the line, yours and theirs. That confidence does give some mental strength.“
“I think the most important thing was we were together as a unit and we knew that if we were in trouble someone would come and did! We fight wars for our countries but we usually die for our Brothers and Sisters in Arms who were beside us. Our fear of failing them overcame other fears.“
“Protecting my brothers was more important than dying. Getting killed trying to save one my brothers was, without ambiguity, completely acceptable to me. It’s a type of mindset that is both extraordinary and completely bizarre. It may sound like a Hallmark card, but yes, love is more powerful than anything the world can throw at you. It’s the endless picking apart of “what just happened” that can eat you alive afterward.“
“Losing face was worse than losing life“
“In the military, you’re taught to value the unit more than yourself. That’s very binary…and the reality is different than that…but the point is…yes, there’s fear for one self…but I’m not going to let my battle buddy, my squad, my unit down.“
“The worst fear a soldier has is this, “How will I act in front of my brothers when the shit show starts? ” That’s the worst fear. How will you act? Sure you’re scared of death but will you let your buddies down? Will you turn into a cowering mess in front of them or will you do your duty and perform your job? This is the unknown factor before first combat. And combat is such a crazy, quick timed, fucked up, loud, confusing adrenaline rush that there is usually no time to decipher anything. It’s very hard to explain but time speeds up and slows down at the same time. You don’t think of dying but making sure you don’t screw up so your brothers can get back to base in one piece. That’s your main thought. Don’t screw up. Sure you don’t want to die, but I feel a worse fear is how will I perform in front of the guys. All in all, it’s a very, very hard thing to explain.“
Now the key takeaways for us on how the army folks handle fear:
- Confidence helps a lot. The most obvious and easiest is to know that you have been well trained, know your job, have knowledge of tactics, weaponry, purpose of mission, trust in your self and your men, and feel confident in those areas.
- You are not alone
- We fight wars for our countries but we usually die for our Brothers and Sisters in Arms who were beside us. Our fear of failing them overcame other fears
- Losing face was worse than losing life
- Accept that you are already dead
Let us see as to how it boils down to investing in a bear market
- Confidence and Faith: Faith in equities over the long run. Confidence in the what-if-things-go-wrong plan.
- Accept that you are already dead: What if we, like the army men mentally wrote off and counted only 50% of our existing equity portfolio. This resonates with stoic philosophy about which you can read my earlier post here
- Commitment and Social Accountability to a group: What if we made a secret group, took a commitment that we would be sticking to our execution plan and made ourselves accountable to the group.
11.The Hundred Punches framework
The idea is simple. We will be creating a group where like minded people who believe in equities but are finding it tough to individually handle a bear market, can find support in each other.
This will be an “Alcoholics Anonymous” investing version for us.
The plan is called 100 punches framework
It is damn simple to execute.
Every week Sunday morning 9 am, we will simply report to the group that we took the punch that the market gave us, and still stood back all set for the next week. Our portfolio plan remains intact and we did not panic.
When the 20% levels, 30% levels, 40% levels, 50% levels (or whichever parameter you are using) gets triggered, we will report during that week that we have successfully executed our pre-built plan (and increased equity allocation).
We will continue this for 100 weeks (and extend it if the bear market prolongs).
The idea to focus on the short term (1 week) is that while returns occur in the long run, most of us experience our portfolios in the short run.
I am yet to decide on the social media platform. Mostly it will be facebook. If you have any other suggestion do let me know.
I will also try to bring in some experienced investors, for their guidance and feedback in the group during a bear market. We will also be having regular discussions on the various real time worries, that you might be facing and will stick to evidence based investing.
12.What are the psychological biases that we are making use of?
- Social Accountability – Commitment and Consistency
- Authority Bias
- Social Proof
- Stoic Philosophy
13)Are you predicting that a bear market is coming immediately?
Of course not. I have no clue when the next bear market is coming. The only thing I am certain of, is that it will come someday in the future.
The more we plan for it, the better we are.
14)When does this group get activated?
We have a problem.
We don’t know if the next “dip” will be a minor correction or the start of the next big bear market.
So everytime the market is down by 10% from its previous peak, we will open our group. We may have a few false starts where it recovers back. But no worries, we shall again open it up during the next 10% fall. This means if Nifty goes below 10,900 or Sensex drops below 36,300 the group will become active.
The false starts are not a bug. But rather the normal expectation.
10) Rules for joining the group?
- This group is not for creating a bear market plan or advising on which funds are right for your portfolio. The assumption is that you know the basics and have already created the plan (for this you need to consult your advisor or do your own research). The idea is actually about how to make us stick to the plan using the power of commitment, accountability and social groups.
- Be nice to each other. At the end of the day, it is about a group of people who are witnessing their life savings getting knocked off each and every day. It is going to be really hard on all of us. So let us not criticize anyone or be rude. Let us keep supporting each other. If at any point of time you think this is not working, just vent it out on me and leave the rest alone.
- If you have a stock based portfolio, then you need to be a lot more proactive and hence this group won’t be of much help. This group is primarily meant for portfolios where the stock picking is outsourced to a fund manager via mutual funds/PMS/AIF etc.
- Make sure you have your emergency fund and short term goals sorted via safer fixed income funds
- There wouldn’t be any market predictions
- There wouldn’t be any fancy intelligent analysis on the external event that caused the bear market. The view is always “I don’t know. But I have a clear plan which I will stick to – come what may!”
- Make sure you have a clear plan in place as to what to do in a 20%, 30%, 40%, 50%fall
- There is no one-size fits all plan. Hence you will need to figure out a personalized plan with the help of your advisor or on your own.
- All of us mostly will have different plans. The only thing we will report is that we have stuck to the intended plan. No one will be verifying it.
12)What is my objective?
Though I read a lot, write often on this subject of behavior finance and work for a financial advisory firm, this doesn’t make me holier-than-thou and I am sure I will be as scared as you during the next bear market. Unfortunately, while everyone advises asking us not to panic, no one seems to have the answer for – “how?”.
So the overall idea is to experiment if we as a group can successfully handle a bear market and implement our plan without panicking. We will have a live journal of what thoughts went through each of us, how did we decide, what did the media report, what were the self-doubts etc and finally how the portfolio ended.
If we are successful in our attempt, this can be used as a playbook for several other investors to handle bear markets of the future.
All the best to us 🙂
13)What if things don’t play out as expected?
The basic expectation is that markets will recover. If it doesn’t then my whole thesis goes for a toss and I will be left with permanent loss of money. Personally, I don’t think this scenario will play out. But if in case it does, you are free to put the blame on me and take my case on how dumb I was.
The only request, if I may ask you, would be to not doubt my intent and integrity. This is the something which I value the most and I can assure you that, I will never ever compromise on this.
As always, you are free to criticize my competency and skills.
Convinced? If you think the whole thing makes sense, then first subscribe to my blog from here, so that I can keep you posted on further updates.
Next step, fill out the form below by clicking this link
I am yet to decide on the platform (Facebook, Whatsapp, Reditt etc) for creating the group. I will wait for the feedback, create a group and inform you about that via mail.
If there are any queries or suggestions do mail me at firstname.lastname@example.org
I am damn excited and hope to interact, learn and survive the next bear market whenever that hits along with all of you.
Happy investing as always:)
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8 thoughts on “Worried about the next bear market. Introducing The Courageous Investing Movement – Are you in?”
I used to have a framework for 10,20, 30% falls etc. Nothing cast in stone but more of a thought process. The funny thing is that market has a mind of it’s own. So the 2018 fall was very different. Sensex/Nifty only had a correction (10%), mid-caps got into bear territory, and small caps were down 40%. That’s carnage.. so having a I realized that having a framework based on market fall may be too simplistic. Perhaps have a framework based on portfolio fall (which would also depend on asset allocation in the first place).
Just my 2 cents on theory vs. reality..
Agree. That is exactly why all of us will need different framework based on our portfolios. If the exposure to mid and small caps.dominate, the falls instead of a common large cap index can be done at a portfolio level .
Thanks for the inputs 🙂
As per previous comment, my most investments are in midcap, so should we use midcap index for 10, 20, 30 % type falls?
As Mr Bogle said keep on indexing and don’t peep you’ll be good.
Great timing Arun and great insights into an investors psyche. I’m not sure how well the group will work but I’m game to be a part of it and get / give support
Very nice write-up on investor behaviour and psychology.
I have tried to fill up the enclosed form for getting me on board to the Group, but, I don’t understand why do you want to tell my date of birth. Why, because, there are many places, where if you forget your password, then, one of the clues to reset it is your dob, and that’s where there is a problem, in the sense, that giving dob can be misused and dangerous by someone in the system or your fraternity. I think simply giving age would be fine.
90% Equity + 10% Debt:
Risk: 25% normal decline + 50% fall in crisis
Return Expectation: 12-14% – double in 5-6 years
70% Equity + 30% Debt:
Risk: 20% normal decline + 40% fall in crisis
Return Expectation: 11-12% – double in 6-7 years
50% Equity + 50% Debt:
Risk: 15% normal decline + 30% fall in crisis
Return Expectation: 10-11% – double in 7-8 years
30% Equity + 70% Debt:
Risk: 5% normal decline + 15% fall in crisis
Return Expectation: 9-10% – double in 8-9 years
How RISK is calculated?