Soul Searching

No doubt, you've heard some or all of these lately:

• We're witnessing the death throes of free market capitalism
• Stock market efficiency has been proven false once and for all
• Buy and hold investing is dead
• The end of credit as we know it
• As a retirement vehicle, stocks are obsolete

And so on. What's fascinating is the common thread: After a bear market, certain schools of thought (nay, entire constructs of economics!) are deemed "dead." Obsolete. Fine for an older, simpler time, but not today. It's new paradigm time! Now is a Brave New World and we need brave new ideas to navigate it. The expedient question is not what to keep, but what to change?

This is heady stuff—the fate of whole investing disciplines in peril! Yet, it happens in the aftermath of every bear. And the bigger the bear, the deeper the soul searching about what truly works and what doesn't. It's not just the "big" ideas in peril. Investors everywhere ask themselves smaller questions like, "Shouldn't I rethink my stock/bond/cash mix?" and "Doesn't it make sense to have less risk than before?"

While folks mistakenly focus on what strategies and philosophies must be changed, you should focus on what to keep. Among the greatest investing mistakes is abandoning basic, tried-and-true disciplines after bear markets. Perfectly good, sound investing strategies sometimes go astray in the short term. But the real and always relevant question remains: Is your strategy appropriate for your long-term goals and situation?

Your asset allocation (the mix of stocks, bonds, and cash) should mostly be determined by your goals and time horizon. The initial plan should account for the possibility of tumultuous times for any asset class, that is, stock market bears. Once a plan is in place, sticking to it is the key to investing success. Dodging a bear market is great if you can do it, but there is nothing about a bear in and of itself that ought to change a long-term, disciplined approach. Bears come and go and are included in stocks' long-term returns.

So why then do we still soul search? Part of it is the near instinctual impulse to believe "this time it's different." (I won't dwell on that here. See my past columns, "Simple Choices" and "The Greatest Redistribution" for more.) But it's more insidious than that. At its core, the perception of danger has everything to do with the concept of movement.

Whether you're out hiking and an actual snarling grizzly appears before you or you witness a sinking stock market chart onscreen, most parts of your brain don't know the difference. Both experiences conjure a neural response of fear, triggering the need to react. The typical euphemism is "fight or flight," but that's really just another way of saying movement. Whether you fight or you fly, your body readies itself to move—take action—in the presence of danger. Stasis—sitting still—is the most uncomfortable, unnatural thing possible. This natural response is well suited for grizzly encounters, but not investing.

Like so many of our innate instincts, this basic feature of the mind often runs against our best investing interests. It doesn't take a PhD psychologist to realize hasty, heat-of-the-moment decisions usually turn out wrong. But we do it anyhow—today, capitalism is widely believed "dead," you see.

Hence, the perpetual tendency for investors to panic and sell at the bottom and/or swear off stocks forever, over and over again, when the rational thing is most often to not change at all. Example: For most investors with all but the shortest investing time horizons, it simply makes no sense to turn defensive after the brunt of a bear. All that does, generally, is disqualify you from participating in the recovery. But to see that, you can't have the "What do I change?" question in mind. Instead, you must think discipline. Staying put can be tough.

Are there things to learn—and maybe even change— about portfolio management after a big bear market? Of course. Markets do evolve, and no one is all-knowing. Being dynamic is an imperative feature of achieving superior long-term portfolio returns. But investing often isn't about being a genius so much as it is about discipline. This wasn't the first bear market and surely won't be the last. You can search your soul for changes, but don't sabotage your long-term goals in the process.