Steer a Steady Investment Course

Keeping your head while all about you lose theirs

For months, media headlines and story lead-ins have been filled with dire warnings and inflammatory statements about the economy.

Phrases like "the road to recession," "dollar debacle," "subprime mortgage implosion," "housing meltdown," "credit crunch," "trading scandal," and "rogue trader" combine with 600-point intra-day swings in the Dow and volatile economic news to bombard our senses almost every moment of every day.

For many, this constant barrage of news prompts a nearly uncontrollable urge to make portfolio or investment changes in the hope of insulating oneself from even scarier potentialities ahead. Even some of the strongest find the barrage wearying and secretly question if they should fiddle, "just a little, here and there." It's a scenario comparable to walking home after a horror flick with a newly acquired, acute startle reflex--jumping with every rustle and snapping twig. Yet from a long-term perspective, there are few things more detrimental to your financial well-being than allowing emotions to prompt you to make radical changes during nerve-wrenching times.

As frequently conveyed by the media, the global capital, credit, and information markets are increasingly tied together. But the implications of that tight accord are not as clear-cut as they might have once been. In prior decades, if the headlines blared something like "Auto Sales Drop," the ramifications were more localized (within the U.S. borders, for example), and the news usually affected specific industries and subsectors more clearly. Since the automakers were typically vertically integrated, a drop in sales meant a pretty direct cutback in production--leading to layoffs, lower consumer spending, etc. Today, the relationships are more multidimensional and global, with drops in production in one locale affecting suppliers, lenders, and consumers in many different places around the globe.

The fact that the underlying economy has become much more diverse and complex seemingly complicates the investment decision-making process. However, ultimate success in the investment arena still requires a solid long-term thought process, coupled with the ability to differentiate short-term market noise (i.e., the daily headline feeds) from long-term trends worthy of note. That means selling when the news is great and everyone wants to own. And quite often, it means making difficult decisions when prospects seem bleakest (e.g., buying shares in good-quality companies when their stocks go on sale).

Time and time again, the stock market starts to rally at the very pit of an economic recession, not after a recession is statistically well in hand. So, while the media tries to decide whether we are or aren't in a recession, the markets themselves are off predicting some event six to 12 months down the road. In contrast, markets generally start to roll over even as the corporate and economic news looks to be so bright one needs shades to view it. To consistently execute a sound investment program requires a steady hand, a strong stomach, and a sturdy heart--rather than the ability to predict next month's economic stats, or the ability to make massive and complete asset allocation shifts on a gut feeling or a whim.

Though public equity markets in the U.S. have been around for hundreds of years, more than 80 percent of today's participants have joined the party within the past two decades. Correspondingly, long-term investment wisdom (as opposed to the plethora of sales pitches for hot stocks and short-term trading systems) can be tough to come by. Still, there are a handful of venerables out there who have successfully navigated the turmoil for 30, 40, even 50 years or more. They have seen industries come and go, and market relationships come and go. They have endured periods of underperformance when short-term trends worked against their long-term convictions. During times that seem especially turbulent (e.g., recent quarters), it can be reassuring to glean nuggets of wisdom from those with proven staying power to potentially employ in our own financial endeavors.

A common thread among successful, long-term investment survivors is their conviction and willingness to act in the face of a myriad of obstacles. They rarely move in the direction of the Wall Street herd, relishing instead their counter-conventional thinking. Most important, they have balanced an ability to stick to core principles with a capacity to analyze and adapt to rapidly changing conditions. While there are dozens of anecdotes to pick from, the following encapsulate the core themes:

Warren Buffett, dubbed the "Oracle of Omaha" by Fortune magazine, is world-renowned for his down-home advice--and the substantial outperformance of his company's (Berkshire Hathaway) shares. In 1998, Simon Reynolds compiled some of Buffett's more famous statements in Thoughts of Chairman Buffett, including one that is particularly pertinent:

"One piece of advice I got at Columbia from Ben Graham that I've never forgotten: You're neither right nor wrong because other people agree with you. You're right because your facts are right, and your reasoning is right."

For decades, Buffett has espoused a consistent theme of stepping up to the plate when others are still sitting on the bench: "I will tell you the secret of getting rich on Wall Street. You try to be greedy when others are fearful, and you try to be very fearful when others are greedy." Or, stated another way in a 1988 Fortune article, "You simply have to behave according to what is rational rather than what is fashionable."

Charlie Ellis, author of a wonderful book on establishing your investment priorities called Investment Policy: How to Win the Loser's Game, admonishes individual investors to "ignore the dance of stock prices, fascinating and seductive as the activity may be. The secret to long-term investment success is benign neglect. Let compounding work for you."

Ellis drives home another nail: "Decisions that are driven by either greed or fear are usually wrong, usually late, and very unlikely to be reversed correctly. The crucial question is not simply whether long-term returns on common stocks would exceed returns on bonds or bills if the investor held on through many startling gyrations of the market. The crucial question is whether the investor will, in fact, hold on."

And of course, there's Peter Lynch, the renowned former head of the Fidelity Magellan Fund. In his book, One Up on Wall Street, he puts it quite simply:
"Before you think about buying stocks, you ought to have made some basic decisions ... about whether you are a short- or long-term investor, and about how you will react to sudden, unexpected, and severe drops in price. It's best to define your objectives and clarify your attitudes beforehand, because if you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at a loss. It is personal preparation, as much as knowledge and research, which distinguishes the successful stock picker from the chronic loser. Ultimately, it is not the stock market or even the companies themselves that determine an investor's fate. It is the investor."

While the pace of change may seem to have accelerated in recent years--and certainly, the coverage of real (and imagined) change has escalated--it's important to remember that change, growth, and adaptation are all a part of a healthy system. Change was also rapid at the start of the last century, with the spread of coast-to-coast railroads; the electrification of the country; and the invention and proliferation of cars, planes, trans-oceanic telecommunications, etc. The markets, economy, and political system all survived--though not without different rules, different regulations, and different participants.

The key to long-term survival in the investment arena is to understand that cycles are inevitable and can provide ample investment opportunities for the nimble, while minimizing the gut reactions that may prompt an unfortunately reactive near-term response to yet another inflammatory headline.

Carol M. Clark, CFA, is a partner and investment principal of Lowry Hill, a private asset management firm that provides proprietary investment management and financial services to families, individuals, and foundations with wealth greater than $10 million. The firm manages approximately $6 billion in assets for nearly 300 families and more than 60 foundations from offices in Chicago, Minneapolis, Naples, and Scottsdale. She welcomes questions and comments at cclark@lowryhill.com.