There are plenty of rules that investors can follow to try to guide their decision-making process with their portfolios. But when times get tough, most of those rules go out the window. Still, there are a few rules that stand the test of time no matter what market conditions you face. Below, you'll get three different perspectives on what investors should do to keep themselves focused on their long-term goals.
Dan Caplinger: The most important thing for investors to do is to have a written plan that details their investing strategy. The best defense against making emotional decisions is to be clear and rational about your investment goals and objectives at your first opportunity. That way, you can check in from time to time and make sure that you're still on track for your long-term goals even if a tough market puts up short-term obstacles in your path.
A good investment strategy will have two components. First, it should have an overall picture of what you want to achieve financially and what resources you expect to commit to help you get there in terms of saving. Second, it should provide for a process to follow when you make each investment. That's especially important if you buy individual stocks, because you can put in your rationale for buying a stock and watch over time to see if that rationale plays out the way you expected. If it doesn't, then the written explanation can help guide a sell decision in a calm and reasonable way that avoids emotional elements. By having an investing strategy in place, you can more easily stay the course even in tough markets like these.
George Budwell: The single most important rule that has guided my investing decisions over the years is to always view Mr. Market's mood as a contrarian indicator. Decades worth of academic research has definitively shown that most investors are easily swayed by the overall direction of the broader markets, leading to a horrendous outcome -- people selling low and buying high. Of course, the opposite should be the case, but again, the empirical data shows otherwise.
Worse still, it's not just the little guys that get caught in this deadly trap. Institutional investors are well-known to be trend followers as well, showing why so few money managers actually beat the broader markets on a consistent basis.
Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) Warren Buffett summed up the problem succinctly years ago, warning investors to "Be fearful when others are greedy, and greedy when others are fearful." By going against the grain and taking emotion out of the equation, Buffett has guided Berkshire to a compound annual growth rate of an astounding 21.6% vs. a far more modest 9.9% for the S&P 500 (including dividends) over the 50 year period covering 1965 to 2014.
Despite the sound nature of Buffett's advice, investors, on average, keep selling low out of fear, as evidenced by the market's free fall this year. Personally, I'm not fazed by this dramatic sell-off and plan to use it to gobble up shares of fundamentally sound companies. After all, the U.S. stock market is the undisputed champion when it comes to creating wealth, and although it can get a tad choppy at times, it has never failed to rebound.
Jason Hall: The hardest investing lesson for me to learn was how terrible people are at predicting what the stock market will do in the short term.
Millions of dollars have been spent studying the market, and not a single reliable, repeatable method to accurately predict the market has been developed or discovered. And for good reason -- it's too complex a thing to predict, with millions of buyers and sellers all with different goals, objectives, motivations, and reasoning for their actions. That's before we even factor in all the unpredictable outside influences, such as global economies, commodity oversupplies or shortages, wars, new technologies, etc. Just too many unknowables to predict what happens from one month or quarter -- or even from one year -- to the next.
Yes, there are general trends up and down that people inevitably follow, but it's the shifts in sentiment -- when will the market turn and start moving up (or down) again -- that we will never be able to predict.
But the long term is much more predictable, because all the short-term noise that causes the ups and downs that George wrote about above tends to have less impact on the bigger picture.
Businesses continue to innovate and sell products and services. The population grows, making the pie bigger. Those businesses benefit from the bigger pie, and they grow, too. And stocks tend to go higher, making -- I'm stealing George's thunder again -- the U.S. stock market the best wealth-creation machine for most of us.
The rule is this: Invest in and for the long term, because you'll fail if you try to time the market.
Dan Caplinger owns shares of Berkshire Hathaway. George Budwell owns shares of Berkshire Hathaway. Jason Hall owns shares of Berkshire Hathaway. The Motley Fool owns shares of and recommends Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.