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This Is The Hard Part

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In 2014 Ben Horowitz, cofounder of Andreessen Horowitz and described as one of Silicon Valley's most respected and experienced entrepreneurs, wrote a book titled “The Hard Thing About Hard Things: Building a Business When There Are No Easy Answers.”

Many people talk about the benefits, rewards and good things that come with starting a business. Few talk about the risks, challenges and difficulties of doing so. Ben’s book addresses these “hard things” when it comes to building and running a business.

With the S&P 500 now down more than 10% from its high in 2015 and many markets across the globe down even more, investors are dealing with the investment version of “The Hard Thing About Hard Things.” Investing isn’t easy during any period, but when a market correction happens, maintaining your discipline and sticking with your strategy is the hardest part.

While difficult, good investors learn how to best react – or not react – during the tough times.

This Is Normal

First, while uncomfortable, drawdowns aren’t uncommon. A drawdown, defined as a market being 10% or more below its high, happens more than most think. Since 1950, the S&P 500 has spent more the one-third of the time in these “drawdown” periods. This compares to only 7% of the time at new highs.

Drawdowns: uncomfortable, but common. Therefore, what matters is having an investment process and strategy you believe in and then sticking with it through the “hard parts.”

The Investment Process

At the highest level, an investment process should look something like this:

  1. Strategy and allocation: What does the evidence say works? Eliminate what doesn’t work.
  2. Discipline: Stick with your strategy through market ups and downs

Sure there are other parts of investing worth optimizing—rebalancing, asset location, tax minimization, fund selection, reducing expenses, retirement withdrawal strategies, etc. are all important enhancements to any strategy. But, if you get your strategy wrong and aren’t disciplined, these two things trump everything else.

The rest of this article will focus on the getting-the-disciple part of the investment process. We will look at:

  • Why is it so important?
  • How do people mess it up?
  • And what can you do?

Why is Discipline Important?

Study after study has shown that poor investor behavior is one of the biggest drags on returns over time. Often called the “behavior gap,” these are lost returns from emotional responses to market conditions.

The following chart from AdvicePeriod summarizes the academic research on investor behavior. Studies find that investors cost themselves between 1.2% and 4.3% annually in lost returns due to “emotional responses to market conditions” or a lack of discipline. Behavioral.png

Separately, Morningstar found that in the 10 years ending in December 2013, investors across all funds costs themselves 2.5% per year due to poorly timed buy and sell decisions. 


Discipline clearly matters, and poor behavior can be a crushing drag on returns. Now let’s take a look at how people mess it up.

Why it’s Hard and How it Gets Messed Up

How do investors end up costing themselves returns? Two ways primarily: chasing performance and investing based on what just happened.

The next chart shows how even institutional investors when selecting managers, are subject to chasing returns. From 1996-2003, the study showed that managers were selected based on their past performance, but this actually translated into negative performance after the change was made. 


And this doesn’t just happen when chasing the hot fund.

The following chart from the Investment Company Institute shows that money tends to flow into and out of assets at the wrong time, too. During late 2008 and early 2009, money was flowing out of stock funds at a rate of around $30 billion per month. Money was pulled out of these funds just in time to miss the massive recovery that took place in 2009 and the subsequent years. In aggregate, investors based their equity allocation decision on what had just happened and cost themselves money, and potentially financial security, in the process. 



So What Can You Do?

Clearly your behavior as an investor matters. So, what can we do to make it through and actually benefit from the “hard part” of investing? Here are some suggestions:

  • Assess risk – While it’s better to assess the risk you are taking before the markets turn down, it’s not too late. If your portfolio risk increased along with the market over the last six years (either by not rebalancing or by chasing returns), it might be the right time to dial it back in line with your risk tolerance. Vanguard estimates that the potential value of rebalancing back to your risk targets adds “up to 35 bps [0.35%] when risk-adjusting a 60% stock/40% bond portfolio that is rebalanced annually versus the same portfolio that is not rebalanced.”
  • Tie your investments to your long-term goals – Make sure to remember why you are investing. Chances are it’s for retirement, college, or some other event many years in the future. As financial author Cullen Roche pointed out recently, “In the last 45 years a globally allocated 60/40 stock/bond portfolio has never had a negative rolling 5-year return.  Of course, it’s not easy to maintain a 5-year time horizon, but if you have less than a 5-year time horizon you probably shouldn’t be owning stocks and bonds in the first place.” 60_40_Rolling.png
  • Take losses – Tax loss harvesting, selling positions at a loss and buying other positions to remain invested, can be used to reduce your taxes. Have a plan in place to use this tactic when the market gives you to the opportunity to do so.
  • Don’t look at your portfolio – We all need a vacation and sometimes a vacation from your portfolio actually increases returns. Fidelity once looked at which of their customers had the best returns. Turns out it was the ones who forgot they had an account and, therefore, couldn’t make bad timing decisions with the account.
  • Turn off your TV – As we’ve written before, “It’s important to remember that financial media exists for one purpose—ratings. It’s not there to break actionable news, give you profitable trading advice, or make you smarter. They simply want as many eyeballs as possible, and will resort to all manner of hype necessary to get them.”
  • Accept the fact that one knows what will happen next – As Wall Street Journal columnist Jason Zweig wrote last year, “After a market drop, or at any other time, no one knows what the market will do next. The one thing you can be fairly sure of is that the louder and more forcefully a market pundit voices his certainty about what is going to happen next, the more likely it is that he will turn out to be wrong.”

Simple, Not Easy 

Clearly, watching your portfolio decline in value isn’t fun for anyone—even the most experienced investors. But typically the most prudent action, as cliché as it sounds, is to stay the course. But don’t take our word for it. In a recent article, Director of Research for The BAM Alliance Larry Swedroe summed it up as follows: 

Warren Buffett has accurately stated that “investing is simple, but not easy.” The simple part is that the winning strategy is to act like the lowly postage stamp, which adheres to its letter until it reaches its destination. Similarly, investors should stick to their asset allocation until they reach their financial goals. 

The reason investing is hard is that it can be difficult for many individuals to control their emotions (greed and envy in bull markets, and fear and panic in bear markets). In fact, I’ve come to believe that bear markets are the mechanism by which assets are transferred from those with weak stomachs and without an investment plan to those with well-thought-out plans—meaning they anticipate bear markets—and the discipline to follow those plans.


Or as Vanguard Founder and former CEO John Bogle puts it, “The stock market is a giant distraction to the business of investing.”



Click here for disclosures regarding information contained in blog postings.
Cordant, Inc. is not affiliated or associated with, or endorsed by, Intel.

Published on January 26, 2016

Isaac Presley, CFA

Isaac Presley, CFA

Isaac Presley is the President and Director of Investments for Cordant, a wealth management firm serving current and former Intel employees. To learn more, you can read Isaac's full bio.

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