“A Little Late” by Carl Richards

Carl Richards’ is a favorite contributor here at the Portfolioist. We’ve interviewed him in the past (see, “How to Pick an Investment Advisor (Part 3): Carl Richards’ 3 Key Questions” by Nanette Byrnes) and remain a fan of his website, behaviorgap.com.

Using a Sharpie and a piece of card stock, Richards captures complex financial ideas in simple, easy-to-understand sketches.

Here’s his latest sketch and commentary on the recent market volatility. Enjoy–we certainly did.

The recent market decline, and the media (over)reaction that followed, reminded me that we still have not learned a very simple lesson: the time to prepare for a “crisis” is long before you find yourself in one. It’s not a good idea to figure out how a parachute works after you jump out of the plane.

The stock market is doing what stock markets do. Yet we run around like it’s such a shock. We don’t know when it will happen, and often it’s hard to tell why, but the fact that the market went down shouldn’t have surprised anyone.

So if you were surprised, here’s what you need to ask yourself:

Why so shocked? Didn’t we just learn this lesson a few years ago?

To be clear: this is not a problem with the market. This is a problem with us. How in the world can you invest your hard-earned money without a plan for both the good and the bad days? Any plan needs to account for the reality that markets go down as well as up. Part of the planning process must include a discussion about risk and even include lifeboat drills to see how you will react before you hit the water.

Unfortunately for people who were surprised, the reaction came in one of two flavors:

1) They didn’t have a plan.
2) They had a plan but didn’t factor in the possibility of a market decline.

In both instances, it’s too late to do anything now about what just happened. You can’t hedge against the past. It’s like trying to get flood insurance after your house floods.

This post originally started out as an explanation about why the market dropped, but I realized that we don’t need to know why the market did what it did. In fact, we will never know exactly why the market went down. But that doesn’t keep the talking heads from speculating, a reality that Marketplace Radio’s Heidi N. Moore illuminated last week:

Here’s what none of those people will tell you: they don’t know. No one knows. There is no education, no M.B.A., Ph.D or even market experience that can now or will ever pinpoint a reason or reasons for a market rout that is not directly spurred by some piece of news.

As humans, we like things to make sense in our little worlds, so we tell ourselves stories. We want others to tell us stories as well, so we can make sense of it all.

Sorry, but no matter how many stories you listen to, the markets rarely make sense, because “the market” is nothing more than the collective representation of what we’re feeling right now … and now … and now.

Just look at how teenagers change the way they feel based on irrational stories they tell themselves about something that happened at school or on Facebook. Now times that by a million! That’s the market.

Again, this isn’t about predicting a particular moment in time or behavior for the market. Instead, it’s about recognizing that big declines happen in markets, and we shouldn’t be surprised when it happens again in the future. Since we seem to have such short memories, I suggest writing yourself a letter or recording a video so you can remember this past week. Use it to remind yourself that you need to learn how to use the parachute before you ever get on the plane.

About Carl Richards

Carl Richards may be best-known for his regular writing at the New York Times Bucks Blog, Daily Worth, and his own “Behavior Gap” newsletter.

A CERTIFIED FINANCIAL PLANNER™, Carl is also the founder of Prasada Capital Management (previously Clearwater Wealth Management), a portfolio design firm that serves a select group of individuals and families. Prasada’s clients share two objectives: to not lose money and to enjoy their lives to the fullest.

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