The Dose of Reality Investors Need Right Now

Editor's note: This Weekend Edition, we're taking a break from our usual fare to share an essay penned by senior research partner Dr. David "Doc" Eifrig. Most recently published in the Stansberry Digest Masters Series, Doc explains why investors should embrace uncertainty... and how being a "realist" can give you the mindset needed to thrive in markets like today's.

No one summed up the "truth" better than English writer Aldous Huxley...

Huxley, who lived from 1894 to 1963, wrote nearly 50 books in his distinguished career. He was nominated for the Nobel Prize in Literature nine times.

And somewhere along the way, he said...

You shall know the truth, and the truth shall make you mad.

That's a great summation of what's happening in the stock market right now. The truth I want to discuss in today's essay can get you rather steamed fairly quickly...

We're clearly toying with the conditions for a market crash these days. Yet even though markets have been down recently, valuations are still stretched near all-time highs.

Let's look at the numbers...

Say the stock market returns about 10% each year. That means it would usually return about 61% over five years (with compounding).

But since 2017, it has returned 110% if you account for dividends. That's an incredible surge over a five-year period.

To get back on our long-term pace of around 10% annually, stocks would only need to return roughly 3% per year over the next five years. That would be a significant stretch of underperformance.

In other words, for the stock market to return to the performance we expect based on a century of economic history... it simply can't keep up its current pace.

That leads us directly into the second half of the "truth" about the stock market today...

The market is going to crash at some point. But you'll go mad trying to figure out exactly when.

Maybe this recent selling is the start of a bear market. Or maybe it's just a bump in the road during a healthy bull market. I don't know... and neither does anyone else.

I know this sounds wishy-washy... or like I'm withholding something valuable from you.

You may be searching for someone who can tell you exactly what to expect – and exactly when to expect it.

So when you're faced with the truth that no one can consistently and accurately predict every single thing that will happen in the market, it's understandably disappointing.

The problem is, most investors are fundamentally asking the wrong question. They want to know for certain what the market will do so they can decide whether to get out or stay in.

During a presentation that Extreme Value editor Dan Ferris and I did together last year, Dan shared a quote from best-selling author Robert Greene...

The need for certainty is the greatest disease the mind faces.

You see, the stock market is an uncertain beast. Instead of driving yourself mad trying to predict every twist and turn, you must understand and embrace the fact that the market does unpredictable things all the time.

The sooner you can accept this, the sooner you can position yourself to prosper.

The truth is that I'm neither a bull nor a bear. Rather, I'm a "realist." I'm the type of person who says, "Nobody panic. Let's all take a deep breath."

Look, I've been through it all. I traded through Black Monday in 1987... the savings and loan crisis that followed into the mid-1990s... the Asian debt crisis in 1997... the dot-com bubble and bust in the early 2000s... the Great Recession in 2009... and of course, the COVID-19 crash in 2020.

Throughout them all, I learned an important lesson...

The only folks who make it out unscathed are those who keep a cool head.

Building wealth as an investor doesn't come from making rash decisions. That's true on both sides of the coin – the way up and the way down.

Yes, maintaining a portfolio takes good investment ideas... But it also requires a careful balance between conviction and position size – and another careful balance between risk and reward.

When the market is rising, it's easy to forget this discipline. It's easy to slide too much capital into the speculative and fastest-rising investments. It's easy to get too greedy.

The best analogy I can think of to show you what I mean is driving down the highway...

On a smooth road with no traffic, you feel comfortable driving faster and faster. The pedal sinks deeper and deeper... And the speedometer creeps higher and higher.

But then, just when you let your guard down, a pothole rocks your vehicle. That's when you realize you're moving far too fast.

You need that dose of reality to remember to stick to a reasonable speed limit. Otherwise, you could lose everything with just one bad move or one divot in the asphalt.

The same thing is true for all types of investors in the stock market...

For professionals, "sticking to the speed limit" often means limiting leverage. For individuals, it means managing your position sizes and your broader exposure to the market.

It doesn't mean predicting when the market will crash. That's the wrong question.

Instead, you must frame your mindset in a different (and better) way. Here's how I explained this idea to subscribers of my Income Intelligence newsletter in October 2018...

Many investors think of the stock market like a rocket that they ride higher and higher. A rocket, of course, goes up... until it doesn't. They think if only they could release right as the rocket peaks, they could float in orbit – the world of the wealthy – and watch the rocket plummet back to Earth.

That sounds fun, but it's the wrong way to approach things. The market doesn't have one trajectory – up and then down.

In order to time the market correctly, you need to get more than just your sell decision right... You also must decide when to get back in. (You may have to pay taxes on your realized gains as well.)

And more often than not, this will happen... The market will whipsaw back upward and force you to buy back in at a higher price, or you'll be forced to sit on the sidelines as you miss out on the bigger gains. More from that Income Intelligence issue...

It rarely works.

Fortunately, there's a better way to play the market's ups and downs. Don't try to time them with an "all or nothing" decision, simply tilt your allocations. It's that easy.

Don't ever decide that it's time to sell all your stocks... or to load every penny you have into them.

You have far more possibilities for how much risk you want to allocate between stocks, bonds, cash, and other investments.

It's a timeless piece of advice that every investor can use in any market environment...

Don't time. Tilt.

Keep your bets properly sized for the risk that they entail.

If you want to speculate in cryptos, go ahead. Non-fungible tokens could work, too. You could even bet that the Detroit Pistons will win this year's NBA title at 1,000-to-1 odds if you'd like. Any or all of these wagers could pay off.

But you must remember one valuable detail if you do that: Bet small!

Your position size needs to be commensurate with the risk and likelihood of the payoff.

The beauty of something speculative like growth stocks is that their entire appeal is in their upside. If they can return 100%, 200%, or more, even a small position will end up delivering a sizable return.

When the upside is big, the bet can be small.

Said another way, proper position sizing is critical for maximizing your returns in unpredictable markets like we're seeing today.

It's important to bet small when a lot of risk is involved... That way, you won't lose a ton if the decision goes against you. But at the same time, you want to make sure that you're taking a large enough position in an investment to get the biggest reward possible from your capital.

It's a delicate balance of risk and reward. But once you learn to apply it every time you make an investment, your wallet will thank you.

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig

Editor's note: With inflation raging, Doc is sounding the alarm on a huge threat to investors. He's calling it a "Retirement Lockdown"... And it could mean millions of Americans will NEVER have the retirement they planned. But don't panic. Doc has prepared for this moment since 2019... And right now, he's sharing a way to preserve and even grow your wealth despite what's happening. Click here to learn more.