Financial Lessons from Driver’s Ed

With so much attention and angst focused on the debate in Washington over the US debt ceiling these past few weeks, it is no wonder the financial markets continue to bounce around.  It seems that TV financial experts and entertainers (financial “expertainers”) often exaggerate events in the marketplace and thus excite the emotions of investors who are swayed by fear.  This emotional ping-pong game results in illogical investment behavior, such as buying at market highs and selling at market lows.  The wise investor learns to look past the colorful adjectives that describe daily market swings and instead keeps his or her eyes focused on long-term trends.

The Long View

My 16-year old son is currently taking his Driver’s Ed course at .  Do you remember the first time you got behind the wheel of your mom’s station wagon?  For me, I remember staring at the road immediately in front of the hood rather than looking 20 or so yards ahead.  Quickly, it became apparent that it was next to impossible to drive safely with such a short-sighted approach to my surroundings.  Even with a straight road, little traffic and perfect driving conditions, it was next to impossible to drive in a straight line when I only focused on the 3 feet of roadway immediately ahead of the front bumper.  When I learned to look further down the road -- taking the long view – I discovered that maintaining a straight line of travel was not only easier, but much safer too.

It seems to me that the same logic applies to investing.  Losing sight of the long term and thinking that you can time the market by selling at the peak and then re-entering the market once it hits bottom is a big mistake.  Timing market shifts is nearly impossible and requires two correct decisions: when to sell and when to buy back in.  While making modest adjustments can add value, investors who make wholesale market timing bets usually lose.  The biggest potential pitfall in trying to time the market is missing the days it’s “up.”  For example, during the 10-year period after the 1973-1974 stock market decline, an investor who missed just 10 of the market’s best days would have also missed out on more than 50% of the market’s price return.1  Imagine that!  And trying to figure out when those 10 best days would occur would have been an impossible task when you consider that none of the days were consecutive, four of the days occurred in a single year, and six of the years didn’t have any of the best 10 days.2   Perhaps the folly of market timing can be illustrated with another lesson from Driver’s Ed.

Route 3 Traffic to the Cape

The left hand lane of the highway is referred to as the passing lane while the right hand lanes are called the travel lanes, right?  In theory this seems correct, but on a Friday afternoon in the summer, all lanes heading to the Cape would probably be better referred to as “parking lot lanes”!  How many times when sitting in traffic do you find yourself wanting to switch lanes?  We’ve all done it; the lane next to ours starts to move so we put our blinker on, scan the rearview mirror and move into the line of cars that are making progress down the road.  And as soon as we do it, our new lane stops and the one we were previously sitting in starts to move again.   So, if you have a long-term investment horizon and are tempted to get out of the market and move entirely into cash because of short-term events, you may be wise to remember the story about Cape Cod traffic jams.

Financial Lessons

While the debt ceiling debate has grabbed the headlines and is currently the most significant risk to the market, the underlying strength of the global economy remains solid.  Company earnings continue to be very strong as corporate America continues to benefit from a resurgent business reinvestment climate and a resilient consumer.  On the other end of this self-imposed debt ceiling crisis stands an economic climate where businesses are earning near record profits, employment is improving, housing has stabilized, and consumers are once again revisiting the malls to spend.

Enjoy the Ride

As we enjoy the beautiful warm nights, think back to the summer shortly after you received your driver’s license.  What joy and freedom we experienced when we used to cruise the streets with the windows open listening to our favorite songs play on the radio.  One of my favorite songs from those days was by The Doors.  Jim Morrison sang, “Keep your eyes on the road, your hands upon the wheel… We’re gonna have a real good time.”

About this column: Steve Davis is a local CERTIFIED FINANCIAL PLANNER™ who has been helping clients for more than twenty years.  You can find out more about Steve and his company, Davis Financial at www.talkwithdavis.com 

The opinions and economic forecasts voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  Research material has been prepared by LPL Financial.

1 Guide to Market Recoveries, American Funds, 2011

2 Ibid

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