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Selling and Surviving

Johnsonburg is a quiet town in the Allegheny National Forest of northwest Pennsylvania. It’s best-known, at least regionally, for its lumber industry and the associated paper mill in town.

But Johnsonburg made national news a few months ago for a different, “disturbing” reason.

A recently constructed highway bypass—a.k.a. a bridge built above a village or town—has led to dozens of frightened deer leaping to their deaths, many of them onto populated parts of the town.

These deer walk onto the miles-long bypass but aren’t smart enough to find their way back off. They get spooked by traffic, or panic from their predicament, and a survival mechanism kicks in:

Stay “trapped” on the bypass and die. Or jump and maybe survive.

It’s easy for us big-brained humans to say, “How about that third option: walk off the bypass!”

But deer aren’t equipped to understand traffic patterns, or bridge construction, or probabilities. In their plight, they rely on instinct, that the only sliver of survival comes from jumping, even though it’s clearly self-destructive.

When zoomed out, it’s stupid. When zoomed in, it’s rational.

And so the deer jump…

Keep this story in mind.

Phil Asks About Bonds…

Blog reader Phil (from Punxatawney?) recently wrote in:

Jesse – I don’t understand why you hold bonds. I don’t know why anyone holds bonds. Can you explain the “problem” with a 100% stock portfolio?


Great question, Phil. You’re not the first to ask.

And I’ll start by saying some people do recommend 100% stock portfolios. Their rationale is simple: a 100% stock portfolio has always outperformed any portfolio with bonds over the long run.

Key words there: over the long run.

Side note: some experts, therefore, claim that stocks always recover. This is a self-defeating prophecy, and a dangerous one.

If you’re young enough to invest your money and pull a Rip Van Winkle, go ahead into 100% stocks. Some people are fine with a multi-decade hibernation of avoiding their account statements.

But most people don’t live in that world.

Sally Sells – What’s Your Risk Tolerance?

An important question in portfolio construction is, “What’s your risk tolerance?”

Or in plain English, “How much money can you lose before getting nauseous?”

`We each have a unique answer to this question. More importantly, our answers in theory might be different than our answers in practice.

Sally believes she can stomach a 20% loss to her portfolio before feeling a hint of stress. Once 30% down, she’d lose some sleep. And when 40% down, she’d fight the urge to panic sell completely.

Something near a 70/30 portfolio is a good starting point for Sally (70% stocks, 30% bonds).

A 70/30 portfolio’s worst full year (1931, in the Great Depression) suffered a 31% loss.

The 100% stock portfolio that question-asker Phil is interested in has suffered a 43% annual loss (in 1931), and up to an 89% peak-to-trough drawdown (in 1929).

Bonds (or another lower-risk asset, like cash) are required to ballast Sally’s portfolio to meet here unique risk tolerance. Year-to-date, Sally is down about 15%.

In theory, she’s fine.

But what if, in reality, she’s panicking?

Sally Panics!

Only when the tide goes out do you discover whose been swimming naked.

Warren Buffett

Only in market downturns does theory get put to the test. Can you really stomach what you said you could?

Sally’s down 15% and freaking out, like an overconfident hot wing eater.

What do we do? How can we help?

We need to educate and, if needed, reallocate.

First, we educate. We need to learn about Sally. Why is she freaking out? Can we teach her enough about the long-term trends of the stock market to help her feel at ease?

If we can’t, then we need to reallocate her portfolio to less risk.

We need to avoid a situation where Sally sells.

Sally Sells

The only people who get hurt on the roller coaster of those who jump off.

– Lots of investors

This quote begs the question: just how scary is a roller coaster that impels someone into jumping off it? And more importantly, how can we reduce that scariness?

How can we prevent people from “jumping off” their portfolios? How do we preempt the survival mechanism that says, “If I don’t sell now, I may never get another chance. This portfolio is headed to zero.”

Mammal brains are similar to one another, sharing the same amygdala that controls fight-or-flight. The same impulse that pushes a deer to jump from a bypass also pushes Sally to panic-sell her portfolio.

Sally sells out of fear, not stupidity. That fear is a survival mechanism. Fear’s goal (much like pain’s goal) is to motivate us into an action that remedies the fear.

Scared? Run or fight!

Touch a hot stove? Reflexively pull your hand away.

To intentionally endure such pain seems inhuman, requiring a level of mental fortitude to bypass (get it?) the very brain circuitry that makes us alive (see below).

In that context, Sally selling her portfolio (or deer jumping from the bypass) is rational. Is it also myopic? Of course. It’s easy for us to see that short-sightedness on the outside looking in. But it doesn’t feel myopic for Sally, or those deer.

“It’s hard to see the picture when you’re standing inside the frame.”


Or perhaps more macabre,

“It’s hard to see the end of the bypass when you’re standing in the middle of it.”

Jesse Cramer, deer expert

Blog-favorite Howard Marks has his own appropriate quote on the topic,

“We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.”

Howard Marks

While Marks is referring to avoiding too much risk, we can also apply his idea to avoiding self-destructive behaviors.

For a deer to avoid self-destruction, we’d say, “Don’t walk out on a bypass.” …if only they’d listen.

And to Sally, or any other investor, we’d say, “Don’t take on so much risk that you’ll panic sell when markets aren’t cooperative.”

History tells us, time and again, that the survival instinct to panic sell is a self-destructive one.

When zoomed out, panic selling is stupid. When zoomed in, it’s rational. We’d all do better to remind ourselves that humans are frequently irrational.

This begs the question, of course: when will Sally panic?

And that brings us back to bonds, or to any other lower-risk asset class. The rationale for bonds, for cash, for alternatives, for diversification, etc. is to prevent self-destructive panic selling.

It’s one thing to admonish investors and say, “Don’t be stupid! Don’t sell your stocks! The market will eventually recover.”

But good luck looking a panicked investor in the eye and accusing them of stupidity for selling. Your accusation won’t work. Their amygdala, the most irrational part of the brain, is in control. It’s begging them to pull their hand off the stove (or out of the box). Can you blame them for listening?

Our best (and only) option is to prevent panic in the first place. Some pain is ok. But panic is not.

“The true cost of long-term investing is a psychological one.”


Build a portfolio that meets your goals in the good times, but won’t mentally break you in the bad times.

I must not fear. Fear is the mind-killer. Fear is the little-death that brings total obliteration. I will face my fear. I will permit it to pass over me and through me. And when it has gone past I will turn the inner eye to see its path. Where the fear has gone there will be nothing. Only I will remain.

Frank Herbert, in Dune

When the bad times have gone past, turn your inner eye to your Vanguard, your Fidelity, or your Schwab accounts.

Only you—and your portfolio—will remain.

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