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What tornadoes can teach us about investing

May 23, 2013
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One of the more moving human anecdotes from the tornado strike in Oklahoma was of a man whose house had been ransacked, painstakingly restoring it to a semblance of order.

“You’re surely not going to go back and live there?” asked a reporter from the BBC. 

“I sure am,” he replied. “This is Tornado Alley. It’s what we do.” 

Being an investor is rather like living in an area that’s prone to natural disaster. You take precautions to minimise the impact, and you hope that when it strikes, you won’t be in the thick of it. But strike it inevitably will - and, more likely than not, at a time when you least expect it. 

The financial expert Charles Ellis sums it up perfectly when he says that investors need to know the difference between the weather and the climate. There are times when the weather’s a pleasant surprise - rather like the unexpected surge in share prices since the start of the year. There are times when it disappoints, and occasionally, even here in Britain, there are freak occurrences resulting in loss of life. 

What really matters is the underlying climate. Let’s face it: grumble as we British constantly do about the weather, we pretty much know what to expect from one of the most benign climates in the world. 

On the whole, the stock market is a good place to be. But, rather like the residents of Oklahoma or all those cities along the San Andreas fault, investors need to be aware of the intrinsic dangers. (It’s surely only fair that there’s some sort of downside to living in California!) 

Another of Charles Ellis’s mantras is that the best thing a new investor can do is to take a brief look at stock market history. There have been bubbles and crashes since markets began, and there always will be. Other than steering clear of equities altogether, all we can do is to minimise our risk through diversification and regular rebalancing. When crashes occur, we need to be brave and resilient, like the homeowner in Oklahoma; to keep calm and carry on, and to remind ourselves that now is the very worst time to capitulate: if we stay in the market long enough, prices will recover and reach new highs. 

Which leads us neatly to our next series of videos. After the success of Passive Investing: The Evidence and Passive Investing Theory, we’re currently working on an eight-part series called Stock Market History: A Crash Course for Investors. In it we’ll be asking some of the world’s brightest stock market historians what lessons can learned from how markets have performed in the past, and you’ll find their insights fascinating. 

We won’t be blinding you with science. Instead we’ll be offering three simple DOs and three simple DON’Ts which should mean that when - not if, when - disaster strikes, you’ll be better prepared than most. 

Photograph by Edgar Rowe, National Geographic Your Shot


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