The Art of Not Panicking

Apollo 13 was meant to be the third spacecraft to land on the moon when it launched from Kennedy Space Center on April 11, 1970.

If you watched the Tom Hanks movie you know that spacecraft never completed its mission to land on the moon. Two days into the mission there was a problem with the oxygen tanks. The crew was forced to orbit the moon instead and fly home without ever setting foot on it.

Jack Swigert was the chief pilot on that mission. After coming home Swigert commented afterward that “Nobody thought the spacecraft would lose two fuel cells and two oxygen tanks. It couldn’t happen. If somebody had thrown that at us in the simulator, we’d have said, ‘Come on, you’re not being realistic.’”

Despite years and years of training, their mission threw the crew a curveball they couldn’t possibly see coming.

As Carl Richards likes to say, “Risk is what’s leftover after you think you’ve thought of everything.”

And so it goes with the stock market.

Here are the daily returns for the S&P 500:

• Last Monday -3.35%
• Last Tuesday -3.03%
• Last Wednesday -0.38%
• Last Thursday -4.42%
• Last Friday -0.83%
• This Monday -7.60%

Not a great week for stocks. Since hitting all-time highs a few weeks ago, the S&P is now down a quick and efficient 19% or so. This was an extreme market move that we don’t see too often. In fact there were a lot of stats being thrown around that were prefaced with, “This hasn’t happened since…” or “This is the first time…”

That’s one of the things you have to get used to in the stock market — surprises happen more often than most investors expect. And the risks tend to come from unexpected places.

Heightened volatility in the stock market tends to translate into increased emotional volatility. And taking extreme positions in your portfolio is the equivalent to adding Red Bull to all of your drinks at the bar.

Can some people handle the emotional rollercoaster that is going all in or all out of the markets? I suppose so.

But eventually your emotions or Mr. Market will get the best of you. No one is good enough to continually push all their chips into the pot or fold every single hand.

Diversification is a wonderful thing because (in theory) it should help you earn a given level of return at a lower level of risk (or volatility in this construct).

But diversification isn’t just about portfolio construction. In fact, for the majority of investors diversification has little to do with Modern Portfolio Theory.

Diversification is a form of risk management in the investment decision-making process. It helps you live to see another day in the markets. It’s never too hot or too cold.

And diversification can help you avoid panicking. When markets go to the extremes, as they are wont to do, holding extreme positions in your portfolio is a recipe for disaster.

Some investors are going to panic no matter what their positioning in the markets. If no one panicked, we wouldn’t be in these situations in the first place.

Diversification — by asset class, region and strategy — is by far one of the most useful forms of panic management I can think of.

While stocks cratered this week, bonds did their job by providing stabilization in a down market. Bonds dampen portfolio volatility but also provide panic relief.

Some people are born with a steady hand while others need to be trained to avoid panicking during periods of heightened stress.

During the 1960s when the United States was in a heated battle with the Russians to land the first man on the moon, they trained their astronauts in one skill more than any other — the art of not panicking.

Ben Carlson is a US based Director of Institutional Asset Management at Ritholtz Wealth Management LLC, author and blogger