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Power Point
Have a preloaded plan to deal with a market decline
It will help you make rational decisions and take advantage of the market if it falls
Let us start with a simple question: Why is it so difficult to handle abear market? Simple. When we are in a cool and calm state of mind, it is difficult to imagine how we will behave in the future, especially in situations that trigger an intense emotional response. This tendency to behave differently under different circumstances is what behavioural scientists call the “empathy gap” or “heat of the moment” effect.
For instance, supposing you are in a calm state of mind, think about how you will behave if the market cracks by 20-25%? Since you have recent memories of quick market recovery, you may think that you will be happily investing more in equities. But remember, this is what your “cool and calm” avatar is telling you. Your “emotionally charged” avatar might have different plans. If you are like the rest of us, it will want to panic and sell out. remember that your own emotions can change you into a completely new person. So, how do you prepare ourselves for a bear market?
While most of us realize that a sharp market decline once every few years is inevitable, we usually take the approach of “we will figure it out when a bear market hits”. Unfortunately, when that happens, given the stress and panic that it puts us through, our rational decision-making process goes for a toss, and usually we are led to making big mistakes. The simple solution is to give our future self some assistance by “pre-planning” exactly how we will act during a bear market, much ahead of time.
A brand that has used a similar strategy in a slightly different context is Starbucks. When Starbucks was expanding big time, it had to hire and train a lot of new employees. Most of them were freshers. While they thought they knew how to respond to angry customers, when it came to the real situation, a lot of them were not able to handle the stress and some even found themselves shouting back at customers. To help its employees, Starbucks came up with a simple solution: “preloaded decision-making”. They simply added an extra page at the end of every employee handbook which had lines like, “When a customer shouts at me, I will ______.” The employee would then plan and write in advance what their exact response would be to similar tough situations. It allowed employees to plan ahead so that they didn’t have to risk losing their self-control under pressure.
A similar approach can be used for handling a market fall. Make a preloaded decision plan specifying when and what decision to make in a bear market. So fill up lines like, “If the market falls by 20% then I will______”, “If the market falls by 20% then I will______”, and so on. Keep revising the plan every six months. It will be better and easier to follow a plan rather than trust your future self who may be under pressure. It will also ensure that you are better prepared to take advantage of the market if it falls. Also, it will serve as a good reference to check how you thought you would behave during a fall (in our cool and calm avatar) versus how you actually behaved.
Now before you dismiss this as too simple a framework, here is a fun fact. Even the legendary investor Sir John Templeton used a pretty similar strategy for buying stocks in a bear market. Templeton, who talked about wanting to buy at the point of maximum pessimism, was a big believer in preloaded decision plans. In normal times, he regularly set target prices and had predetermined buy orders for stocks that he liked to buy in case the prices fell. He acknowledged that it would be really difficult even for him to buy in the middle of a market fall. So even Templeton had his preloaded decision plan ready. How about you?
Arun Kumar is head of research at FundsIndia.com
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First Published:9 Nov 2020, 08:28 PM IST
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