7-Minute Read
“Be able to see both sides of stress but choose to see the upside.”
- Kelly McGonigal
Let’s talk about stress. At the time of this writing, it has been about one month since Russia invaded Ukraine. The brave Ukrainian citizens are going through the ultimate form of stress. Perhaps it takes situations like this to remind us not to take our individual freedoms and democracy for granted. These are not guaranteed and sometimes must be protected through the greatest of sacrifices.
On one hand, it can seem selfish to think about your own stress when there are millions simply fighting for their lives or trying to start a new life after evacuation. But it’s natural to get anxious about the state of the world. It’s fair to wonder how extreme world events and day-to-day stressors can impact your wellbeing.
In this piece, I touch on three themes that may help you put stress in the right perspective, hopefully for both your life and investment strategy.
- There is an upside to some forms of stress.
- It’s possible to view the stress of investing in a positive
- There is stress being both in and out of the markets.
Stress in the Right Doses
Stress appears to be a mainstay of living in a modern world. There are probably endless demands on your time between work, family and all the other things that require your attention.
You’ve probably heard that too much stress can have a detrimental effect on your physical and mental health. This is particularly true of chronic stress, the type that is frequent and occurs over a prolonged period. Those fighting for lives in the Ukraine are facing the ultimate form of chronic stress over the last month. But your body’s stress response can be activated by life events far more benign than war conditions.
Perhaps you’ve found solutions to manage your own stress. A few things that have helped me over the years are yoga, breathing exercises, physical exercise, and meditation. Sometimes I use those techniques in combination. One key is finding the right coping mechanisms that work for you.
The Upside of Stress
The good news is that not all stress is bad. Kelly McGonigal in her book The Upside of Stress shows how certain types of stress that don’t threaten your survival can turn out to make you stronger. Much comes down to mindset. McGonigal notes through scientific studies how stress is harmful when you believe it is.
I find that fascinating. If you view stress as harmful, you will try to avoid it or possibly let your body absorb the negative effects. If you view it as helpful, you can come up with strategies to cope with the source of the stress and make the best of the situation.
A similar point was made in The Stress Code by Richard Sutton. Sutton shows how stress is really a prerequisite for growth, improvement, and personal advancement. For example, he has seen and cultivated this in the professional athletes he has worked with. One of his core ideas is this: Stress in small doses can help you adapt, find new solutions and achieve your goals.
Are You a Stressed-Out Investor?
If we extend this to the financial domain, investing can often be stressful. You can know intellectually that there will be a fluctuation of the markets over time, but it doesn’t make it easier to live through the down times. If you get caught up in news about the world around you, it can lead to further anxiety.
Is there a way to view the stress of investing in a way that is helpful for achieving your long-term goals while preserving your mental health? I believe it’s possible.
Viewing the Stress of Investing in a Healthy Way
It may first help to remind yourself why you’re investing. Not everyone will have the same reasons for investing. One reason that I personally like goes something like this: I want to deploy my investment capital productively to provide my family with sustainable income that lasts multiple decades and keeps pace with a growing cost of living.
The point here is to come up with your own “why” and it may make the “how” a little easier. You might next want to have a reasonable understanding of the investments you own. To help with this, we can take a little closer look at two concepts: Uncertainty and Diversification
Uncertainty Can Be Your Friend as an Investor
The closest thing we have to a “risk-free” rate of return in the markets might be one-month US Treasury Bills. Since 1926 they have not had even one single down year. On the other hand, the returns have been so low that you would typically lose purchasing power over most historical time periods due to inflation.
If you can earn enough to reach your financial goals with Treasury Bills, then you may not have a compelling enough reason to invest in any other markets where your capital is subject to losses. I imagine that you need (or at least want) some productivity of your investment capital. This is where uncertainty comes into play.
In the real world, uncertainty is abundant. Businesses are constantly operating under risks that are difficult to quantify. These include natural disasters, pandemics, legislation changes, actions by competitors, litigation by customers and so on. Opportunities arise for investors because risk and return seem to be inextricably connected. This drives concepts like the equity risk premium which historically is an excess return over the risk-free rate, essentially compensating investors for risking their capital.
Because there is uncertainty about future events, the conditions arise for you as an investor to possible earn a higher return above the risk-free rate.
Major world events, like this war in the Ukraine, have had and may continue to have an impact on market prices. But the cause and effect can be difficult to extract. Whether there is good news or bad news, stock prices may simply not move in the direction you expect. That uncertainty should get priced into assets, and it becomes one of the main reasons why investors can earn a higher return over time.
One word of warning. Beware of investment products that promise to remove the uncertainty from your investment experience and still provide adequate returns. As an example, I wrote about this in an earlier blog when discussing equity indexed annuities.
Of course, dealing with uncertainty is not the easiest thing to do as a human being. When investing, you should be prepared, possibly with the help of financial planner, to apply some level of discipline during a crisis. If you can manage to take a long view and set realistic expectations, you might just be able to make uncertainty your friend.
Embrace the Power of Diversification
This war in the Ukraine, as tragic as it is, does provide a reminder of why it’s so important to be diversified. Since the start of the war, Russia’s economy has been hit very hard due to broad economic sanctions and large private sector businesses pulling out of the country. Among other things, these have caused a sharp drop in the Russian currency (Ruble) and created a large inflation spike in Russia. To top things off, the Russian stock market has been shut down since the start of the war.
If there’s a silver lining for investors, a major event in one market may not affect stock prices in all markets. This is one reason to hold a globally diversified portfolio.
The chances are that if you own some emerging market investments, say through a mutual fund or exchange traded fund, you will have very little direct exposure to Russian companies. That may have been true even before the recent economic collapse in that country.
Does diversification work? I think it can work both psychologically and tangibly in practice. Since this piece is mostly about stress, I believe diversification can help you stay disciplined and invested during the difficult times. It can help you be more resilient through the uncertainty we discussed earlier. In a practical sense, it can also lead to better returns over a longer period. For an example, see the earlier blog piece Two Decades – One Timeless Investment Lesson.
I’d like to add a couple of technical notes here:
- These are times that I appreciate working with an investment management firm like Dimensional Fund Advisors (DFA). They help me monitor global events and the potential impact on the portfolio management process, such as changes in liquidity, to make decisions that may benefit my clients.
- Notably DFA took a systematic underweight in Russian securities several years ago. Furthermore, any Russian company shares are purchased through listed securities in major exchanges, not by buying directly with Ruble-denominated currency.
Now there may be one final reason why it may be better to live with the stress of investing rather than trying to avoid it.
There’s Stress Being Both In and Out of the Markets
It’s important to remember that when you move in or out of the market in response to some event, you are making a prediction. If the news causes you to move in, you would presumably be expecting a positive return. If you move out, you would be expecting a negative return.
I’m not too concerned about whether your predictions are right or wrong. If you have taken this approach long enough (and survived), then you are likely to have had both wins and losses. But are you confident it is a sustainable strategy going forward?
You might ask yourself: Do you believe markets are incorporating all available information or not? This kind of question comes up during discussions about how efficient the markets are. I believe the answer to the question is yes for most of the time and for most practical purposes. One way to test that is to see how quickly a stock price rises or falls based on the release of new information. Put another way, once information is known to the public, prices have already adjusted, and it happened almost instantly.
The next problem is if you decide to exit the market after a major crisis, you must then decide when you are going to return. What criteria are you using to decide when you will return? I wish there was a “green light” indicator you could rely on. The sad reality is often that the stress of being in the market just gets replaced by the stress of being out of the market. Some may call this the fear of missing out.
Depending on how your portfolio is structured, moving in and out of the market can create additional costs and have tax ramifications. Think about whether this is the way you want your lifetime investment experience to be. My hope is that there are better ways for you to use your valuable time and direct your attention. If there’s going to be stress, maybe you can mitigate the portion that comes from the investment domain.
If you have comments or questions on this piece, please drop me a line at: [email protected]
References
- https://www.amazon.com/Stress-Code-Surviving-Scientific-Resilience/dp/063994664X#:~:text=The%20Stress%20Code%20is%20a,you%20to%20thrive%20in%20adversity.
- https://www.amazon.com/Upside-Stress-Why-Good-You/dp/1101982934/ref=sr_1_1?keywords=the+upside+of+stress&qid=1647806376&s=books&sprefix=the+upsdie+o%2Cstripbooks%2C121&sr=1-1
- https://www.treasurydirect.gov/indiv/products/prod_tbills_glance.htm
- https://www.investopedia.com/terms/e/equityriskpremium.asp#:~:text=An%20equity%20risk%20premium%20is,higher%20risk%20of%20equity%20investing.
- https://krishnawealth.com/look-beyond-the-allure-before-using-equity-indexed-annuities/
- https://krishnawealth.com/two-decades-one-timeless-investment-lesson/
- https://www.dimensional.com/us-en/insights/navigating-geopolitical-events
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