Start preparing for the next market downturn. Now!
It is in times of security that the spirit should be preparing itself for difficult times; while fortune is bestowing favors on it is then is the time for it to be strengthened against her rebuffs.
– Seneca
Finance is booming. The ASX is up over 10% from the start of the year, the US market is up over 20% from Jan, and crypto is up between 66% and 455% on the major coins (Bitcoin and Ethereum) if you’ve thrown your hat in that ring too!
But this won’t always be the case.
This isn’t a blog post about when or why the next market downturn is coming. It’s a post about the fact that, it will come at some point, now is the time to start preparing.
Ms. FWM and I just turned the final page on what has become my favourite book on investing, The Psychology of Money, by Morgan Housel. It’s become my favourite book because it focusses on the one thing that has the biggest impact on whether or not we’re likely to reach FIRE, how we think about money and investing.
I will share some of the lessons this fantastic book over the coming months and years, but for today, I wanted to share some thoughts about how to begin to prepare, mentally, for the next economic downturn.
Why do I need to start preparing?
We all need to prepare for the next market downturn for one simple reason, for the consistent investor, the single biggest risk to your investment returns is how you choose to behave during a significant market downturn. Housel writes:
There is an old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing. Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control. A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy
– Morgan Housel, The Psychology of Money, pg. 77
Unfortunately I learnt this lesson the hard way. I was insufficiently mentally prepared for the severe market declines at the start of 2020 and it resulted in me making some poor investment decisions. Those poor decisions set us back by many years on reaching our FIRE goal. I thought I was prepared. I thought I was ready. I thought I was a ‘smart’ investor. But when I was seeing red every day, what I thought I’d learnt went out the window.
I’m not proud of what I did, but I mention it because I think it’s important to share these kinds of lessons to try to help others (and future me!) not repeat these mistakes.
Fun fact: I kept a diary during this time, and one day I’ll share it, probably during the next serious downturn!
But how can I mentally prepare?
The first thing to note is that if you already think you’re prepared, you maybe but, but there’s also a reasonable chance that you’re not.
I definitely felt prepared, I had the following lines playing over in my mind even as I made my investment mistakes of March 2020:
- It’s time in the market, not timing the market – a common phrase in investing
- The first rule of compounding is to not interrupt it unnecessarily – Charlie Munger
- The four most expensive words in the English language are, ‘This time it’s different.” – Sir John Templeton
- a number of words and phrases must be excluded from the intelligent investor’s vocabulary. These include “never,” “always,” “forever,” “can’t,” “won’t,” “will” and “has to.” – Howard Marks
I was educated, I knew the lingo, I even knew the references. But it wasn’t enough. So, here are some simple things I’m doing, and you may like to do too, to try to prepare for the next downturn.
Make smart investing social – and with the right people
One of the issues last time is that I was talking about finance with people who were in finance, not in FIRE. Family and friends who thought that being active during a downturn, rather than just using a buy and hold strategy, sent messages to me that conflicted with the common wisdom of the FIRE community (and I was a bad influence on these friends and family too!).
Choose wisely the people with whom you speak about investing. They’ll impact you whether you like it or not!
I’m lucky enough that Ms. FWM is incredibly stoic when it comes to investing. She basically didn’t look at her portfolio right throughout the 2020 downturn. She just kept plugging away. I made most of my stupid personal finance decisions without consulting her. I won’t make that mistake again.
Together, we’ve leveraged her stoicism, and my financial proactiveness, to establish a trust fund to invest and combine our investments (I’ll write a blog post about this some time too). We also now invest together, consistently and every month (see our progress here). The trust also means that selling is harder than before, we need to write a trust minute, and talk about the decision too. This additional barrier, as well as the fact that this team approach makes us constantly discuss and reinforce our investing philosophy, is a great protective barrier against being dumb during downturns.
Read and Learn!
We really need to make sure we read and learn, and have a collection of valuable resources at our disposal, before we face the panic of a market downturn. Here are some resources that I’ve been finding particularly helpful.
Blogs
What’s in my Portfolio (and how I manage it), by the Mad Fientist. This post is AWESOME! My favourite bit is the heading, Catching a Falling Knife (More Intelligently), which details a clear plan for investing excess cash during a downturn. This is exactly what I needed in March 2020. If only I’d know about this in March 2020.
Should I try to time the market?, by The White Coat Investor. I really like this brief section in this post entitled, Famous, Smart People Who Say You Shouldn’t Try To Time The Market. It also backs up some of the narrtive from the Mad Fientist above
Weathering the Storm, by the FI Explorer. This blog post shares the FI Explorer’s experience investing through the 2008 GFC. It’s powerful because it tells the story of how it can be tough to invest every month, yet have less money at the end of each month than when you started! But it also shows how valuable doing this is, because the FI Explorer has now reaches his FIRE goal!
Howard Marks’ Memo, by Howard Marks. Sign up for Marks’ email list and he’ll send you a grounded, well thought out, memo about investing and markets on a regular basis, and more frequently if there’s a market downturn. I only discovered this after I’d made my big mistake/s. I read back through his issues from Feb and March 2020 and thought to myself, ‘Crap. This is exactly the advice I needed at that time, I wish I’d found this earlier!
A Guided Meditation for When the Stock Market Is Dropping, by Jim Collins. Legend of the FIRE community, Jim Collins, offers just what is in the blog post title, a recording and video to guide you through a meditation and chill you out when you’re panicking due to a market downturn. Admission: I did half of this meditation during March of 2020, then I switched it off and started researching how to short the market. Yeah, don’t do that.
Warren Buffet’s Advice for a Stock Market Crash, The Motley Fool. Not the most reputable financial news source, (the Motley Fool), but it’s basically just quoting Buffett, who is great!
Books
The Psychology of Money, by Morgan Housel. As mentioned, this book is the absolute best thing I’ve read for coming to terms with your own psychology, and understanding how successful long-term investors think about money. After the Barefoot Investor, this is the second book that anyone pursuing FIRE should read in my opinion. (this is a real page turner of a book. Not technical at all. Read it!)
Mastering the Market Cycle, by Howard Marks. Howard Marks runs Oaktree capital and the memo mentioned in the blog section above. Like Housel, Marks outlines the psychology that drives markets, and shares important lessons for investors, including those of us pursuing FIRE (this book is more technical and requires a bit of perseverance, but it’s great for those keen to go a little deeper).
Make sure you’re comfortable!
The first step in investing should be to ensure that you’re comfortable. Scared money never wins.
– Howard Marks on the Tim Ferris Podcast
Whatever you do, however you set up your portfolio, make sure that the first thing you take care of is how you feel about your financial set up. If you’re overstretched for a house, that stress will become greater during a downturn. If you’re leveraged into shares, that stress will also be compounded. Any baseline stress level relating to finances will be multiplied as soon as your investments start going south, so ensure you have a margin of safety, and comfort, built in!
Closing words
Stay vigilant, stay humble, stay focussed. Establish a habit of investing, and make it automatic and hands off if you can. Focus on the long-term, and focus on building your human capital (and your ability to make money) rather than finessing your financial strategy. A simple three-fund approach is all you need to get you to FIRE, especially when coupled with a structured way to track your spending and expenses.
It’s impossible to know how you’ll emotionally respond when you see your net worth declining rapidly. I thought I was prepared. I couldn’t have been more wrong. This is one area of FIRE where over-preparing can never go astray.
A genius is the man who can do the average thing when everyone else around him is losing his mind
– Napoleon, as quoted by Morgan Housel