Building a Personal Margin of Safety *

“The past couple of weeks of market volatility help underline the challenges investors have focusing on the long term. This is in part due to the fact that the ‘long term’ is made up of a series of ‘short terms.’  The idea being that we think things will change very little over time despite knowledge of past changes. There is a big gap between what our youngest selves think our goals will be versus what our actual goals turn out to be. Most likely whatever your goals are today, you’ll wish for something different in the future.

Knowing that we really don’t know how the future, or our reaction to it, will play out what are investors to do? One approach is to avoid doing stupid stuff. Try more to profit from always remembering the obvious than from grasping the esoteric.  It is remarkable how much over the long term can be gained by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, ‘It’s the strong swimmers who drown.’

That's why it is important to make some fundamental decisions about your investment process and automate them to the greatest extent possible. If you have to constantly rethink every decision it give you more opportunities to do ‘stupid stuff.’ The markets are very volatile and with all of this noise comes hundreds of opportunities to rethink the good financial decisions we’ve already made. It’s so tempting to latch on to predictions and believe they mean something. But unless something fundamental has changed in our lives, these so-called opportunities actually represent a huge brain drain and present a danger to our financial health.

One way we can combat an uncertain future is to save and invest more. Save more. Just save more; if you’re still working, you probably need to save more because you almost certainly aren’t saving enough. I just suspect that’s the case. So my guess is that you can pretty well predict somebody will wish they’d saved more even though they had to give something up.

It is probably best to focus on those simple things you can control. Investing success is incredibly simple; spend less than you earn, make consistent investments in the global market, and wait. If you do these three things, you cannot help but succeed as compounding works for you over time. But simple doesn’t mean easy. That last step, waiting, is incredibly hard to do in practice. We always want to do something with our portfolios, and usually at exactly the wrong time

None of this is easy. We are by and large fragile creatures who are easily knocked off track by what life and the markets throw at us. That is why putting in place some rules to combat our worst tendencies is important. Try to deal with our inability to accurately predict how things will turn out. Be humble. Avoid errors; they cost more than good decisions earn. Plan for the worst even as we hope for the best.

Formulating for ourselves simple rules we can follow over the short run will hopefully help us get to our ever changing long term goals. There are of course no guarantees. No one knows what the future brings, especially stock market pundits. All you can do is focus on building up some personal margin of safety over time. Things rarely turn out the way we expect. We never have everything covered. Life happens. Act accordingly. You have been warned.”

* Adapted from “Building a Personal Margin of Safety;” http://abnormalreturns.com/