This too shall (eventually) pass!

More than 2,000 years ago, a Persian king who felt insulted by an Egyptian king, decided to wage war against the mighty empire of Egypt. The tale of this war might have been unremarkable had it not been for a particularly devious kind of psychological warfare employed by the cunning Persian king.

Knowing that the Egyptians held cats to be sacred (Wait, have I descended from the Egyptians too?), the Persian king had cats painted on the shields of his soldiers. He also sent his soldiers into battle with live cats that they were free to deploy at will. The Egyptians, being completely unprepared for the presence of cats on the battlefield, were overtaken by panic, doubt, and uncertainty, and failed to put up much of a resistance. Egypt, a nation that had once been a cultural and technological superpower, ended up being defeated and annexed by Persia.

Avert your eyes, cat lovers!

Source

While this story might just be a figment of an ancient historian’s imagination, the point it makes about human behavior echoes throughout every era and every society in history: individual and collective fear in the face of novelty and uncertainty can easily overtake logic, reason, and common sense, at times leading to catastrophic outcomes.

Fear and the economy

Similar behavior is seen manifesting itself in an especially damaging way just before and during major economic downturns, financial crises, and recessions (i.e., relatively long economic slumps). Looking back at the last 200 years, one will find dozens of well-documented financial crises and recessions where irrational fears and a herd mentality had a clear role to play in the situation getting out of hand.

Here are just a few choice examples of such events:

- The British credit crisis (1772-1773): At a time when bank lending was booming, a banker named Alexander Fordyce used his bank’s funds to bet against the East India Company. This turned out to have disastrous consequences: the bet failed, and the banking house he was a partner in went bankrupt. This shook investor confidence in banks, leading crowds of people to gather at banks demanding their deposited money back. This resulted in twenty major banking houses collapsing in a short period of time, and dealt a severe blow to trade and public credit.

- The Panic of 1907: This was a financial crisis that played out in the US for over three weeks in late 1907. With the US already in the grip of a recession, a failed attempt to monopolize the copper market spiraled out of control, causing the New York Stock Exchange to fall almost 50% from its highest point in the previous year. This led to widespread panic, leading people to want to withdraw their money from banks right away, as they feared that their bank might go under. This eventually led to the collapse of a major bank, with many others just barely escaping bankruptcy.

- The Bursting of the Dot-Com Bubble (2000-2002): During the 1990s, when the World Wide Web was still new, an incredible number of Internet-oriented companies sprung up. A particularly new kind of irrational fear took hold of investors at that point: the Fear of Missing Out (FOMO). Even companies that had never turned a profit found it easy to raise capital and carry out an IPO. The widespread absence of rational business models eventually caught up with the entire tech industry, with jittery investors finally starting to pull out their investments in 2000. By 2002, tech stocks were mere shadows of their former selves, and many sexy-sounding companies had simply vanished.

These and many other crises all around the world have led to the ruin of economies, companies, and individual investors as well. All these crises could’ve ended sooner and could’ve had a less devastating impact if we’d all cultivated some of the traits of Spock, the ever-logical, ever-cool-headed Vulcan from Star Trek.

Source

Where are we now: Recession Incoming?

Alas, we are only human, and emotions are a major part of our wiring, whether we like it or not. And once again, we stand at a point in time where our emotions are going to be put to the test: observers and experts concur that there is a very real risk of a recession soon. Or is it already here?

But wait. How did we get here? The main precipitating factor was COVID-19, as you might expect. The first waves of infection in early 2020 led stock markets around the world to fall, and the months that followed were witness to lockdowns (often implemented hastily), widespread layoffs, and decreasing consumer activity. At some point, the US Federal Reserve began printing massive amounts of cash in a bid to add liquidity to the markets, which has now caused inflation to hit levels not seen in decades.

To this already unfavorable scenario, add the ongoing Ukraine-Russia war, growing unemployment, rising housing costs, and growing inequality, and you have the whole world wobbling at the edge of a dark cliff.

Now, in the minds of ordinary citizens in many countries, they have already plunged into the darkness, and they are already in damage-control mode: “Buy less. Spend less. Save more. Pull your money out of the stock market, it’s too risky. In fact, pull your money out of super-safe government bonds as well, since they’re not even beating inflation. Just hold on to cash for the next few years. Jobs aren’t safe either. And look at the Sharmas, they just refurbished their bungalow while I can’t even think of getting minor repairs done at my tiny apartment. Maybe they’ll now be unable to pay for it. Hmph!”

This is what many people around the world are feeling: worry, envy, frustration, resignation. But underlying it all, they feel fear. Fear of the way things are unfolding, fear of the unknown. This fear is palpable and can easily spread to everyone these people come into contact with.

And you know what the real irony is? It’s that a fear of impending bad times can bring about those bad times. Such large-scale societal fears often end up being self-fulfilling prophecies.

In such a gloomy atmosphere, what kind of approach should you take towards your existing and planned investments? Should you also assume the worst, and take decisions accordingly- just like everyone else might be doing? Whoa, not so fast. We’ve discussed in the past why it’s important for investors to not follow the herd without questioning. Click here to read “Will you jump off a cliff too?”

Moreover, there’s a key idea I think you should bear in mind when dealing with your investments when fear looms its head, and I’m going to present it through another incredible story.

How to tame the panic monster

It was April 1970. Apollo 13, the third manned mission to the Moon, was on the verge of entering lunar orbit. Everything was going according to plan. But everything went downhill in an instant when the astronauts suddenly heard a small bang, and the craft began to vent gasses into outer space. “Houston, we’ve had a problem”, solemnly relayed the command module pilot.

Three men stuck in a spacecraft with a hole in it. 300,000 kms away from Earth. Surely this is a death sentence for them? Surely, the last transmissions exchanged between them, and mission control consisted of nothing but panicky voices growing louder until they degenerated into screams before the final silence?

Surely, there was nothing to be done here?

You’d be forgiven for thinking so. But this is NASA we’re talking about. They have clearly laid-out plans to deal with potentially deadly situations, and systems and protocols to deal with completely unpredictable events.

So, Mission Control didn’t panic. The astronauts didn’t panic. Mission control collected all the information they could from the astronauts and the onboard sensors, came up with an improvised plan, got the astronauts to pull off some technical hijinks within the craft, and managed to bring the astronauts back to Earth, alive! (If all this sounds exciting, you must watch Apollo 13, a Tom Hanks classic)

Source: NASA, Public domain, via Wikimedia Commons

“That’s a rousing story”, you might say, “but what does it have to do with my investments?” Well, it has to do with emotions. There’s a key lesson here about emotional control, revolving around systems and protocols- and like we believe at DSP, frameworks.

Apollo 13’s crew made it back alive & kicking, partly because they trusted the systems and protocols put in place by NASA. They knew that an emergency would lead to a particular kind of response, based on a particular kind of approach. There was (almost always) a plan. Knowing this must have helped them to not succumb to despair, as most people would have.

And this is the key idea that you can apply to your investments as well.

How to minimize the impact of your emotions

Investors can get spooked in a variety of ways:

• There might be widespread talk of an upcoming economic slowdown, true or not
• An actual economic slowdown might be afoot
• The prices of certain star stocks might have fallen
• The prices of a few ‘sure shot’ stocks might not have risen as much as they thought they would

And so on. One can go on and on.

The point is that some of these reasons for worry might simply be noise, with no actual meaning or significance behind them. Not based on any fundamentals. For instance, stock prices generally fluctuate randomly, and statistically, some big dips and rises are going to happen from time to time. It is a fact, not a ‘potential’ theory. Reading too much into said fluctuations and drawing unwarranted conclusions from them, are what can upset an investor’s long-term profitability chances.

Historically, one of the best ways to make a killing in the stock market has been to buy high-quality stocks and then hold them for very long periods, sometimes indefinitely. The problem with this, of course, is that when fear starts to overtake us, we may start second-guessing absolutely everything, including whether or not such long-term investing works, and whether or not the stocks we’ve invested in are actually good picks or just temporarily disguised trash.

And once you’ve lost your mental footing in this matter, your mind can often make you take disastrous actions, such as pulling out of extremely promising investments at a loss. Even though when you invested, your stated time horizon was decades!

Thus, what you need to do is to have a dependable, self- sustaining system in place. It doesn’t have to be complicated: all you might need is some journaling. When you’re planning to buy a stock or a mutual fund, note down all the pros and cons (at least the ones you can think of), and your ultimate prognosis for that stock- the ‘why’ behind your buying it and the ‘how long’ you’d ideally want to hold on to it.. This will ensure that even in distress or panic, you’ll have some reasonable point of reference to come back to, which can hopefully help you snap out of it. Some reason, between the chaos.

Similarly, have a written plan for what you will do in specific scenarios, and why. The market just experienced a flash crash of 20%? The RBI has raised interest rates by 50 basis points? Realiance (no resemblance to you-know-who) is about to acquire yet another company whose stock you’re invested in, as they often do? Have a well-reasoned plan for these situations, and for any other situations that you might think of. Try to imagine unlikely but possible scenarios and see what kind of a response you can come up with. Make sure you meticulously compile everything you write down: sticky notes aren’t enough. 😊

The very fact that eventually you will have a repository of such scenarios and responses to them, and that you can turn to it at any point of time, is likely to help you fend off any hasty, fear-based decisions.

Delegation: a smart way to keep fear from impacting you

Having such a systematic approach to investing is better than nothing, but your fear could still get the best of you, and you might end up greatly diluting your potential future wealth in a moment of weakness. One way to get around this is to entrust your investments to experts with stellar track records. Paradoxically, delegating the management of your investments might actually give you more control over them, as your investments will no longer be directly subject to your emotions: you’ll have taken at least your own fear out of the equation.

And this is where expert MF Distributors can help. Here’s more on this.

And finally

If you want to make good returns over the long term, train yourself to understand that Bulls are nice, but Bears can be awesome (opportunities) too. Keep your head when things aren’t going your way- that’s the best way to make it through to the other side.

Stick to your original plan, and if you can’t tell yourself what it is right now, you probably don’t have one. Go back to the drawing board, ask yourself (or your MFD) what’s the best course of action if things turn sour and jot it down. So that when you find yourself in an actual bad situation, you basically know what to do.

Let me give you one good starting point which you can use to evaluate your own investment decisions till date. Try this free tool from DSP which will help you identify your risk-taking index score and generate a personalized asset-allocation recommendation strategy. Then simply compare what you’ve done till now with your investments (at least in terms of asset allocation) vs what our tool tells you. It might just help you get on track.

As I close, let me remind yourself that investments, like life, go up and down. Sometimes they can stay there for a long time. Arjun, a friend of mine from college, used to love the funky 1987 Hindi movie Mr. India. His favorite song was one I (and most of our common friends) thought was quite cheesy. Recently, Arjun succumbed to cancer, and the song’s lyrics turned far more poignant for me. Perhaps you’ll like them too, given the context of what we’re talking about today.

ज़िंदगी की यही रीत है 

हार के बाद ही जीत है

थोड़े आंसू है, थोड़ी हंसी 

आज ग़म है तो कल है ख़ुशी