Market insights and analysis

By Jerry Wagner

Years ago, a harrowing news story that ultimately ended in triumph reminded me of the benefits of having a plan B.

It all began on August 5, 2010, with the collapse of the main ramp into a small gold and copper mine located in the remote Atacama region of Northern Chile. More than 30 miners were missing. Then, two days later, as hundreds of their fellow miners worked to find some sign of life, a new cave-in brought the rescue efforts to a halt.

For 17 days, the nation, then the world, held its breath, awaiting some word of the fate of the missing. On August 22, a small drill reached almost half a mile into the earth.

From 2,200 feet below the ground came faint tapping sounds. A few more feet and the drill broke into open air—a cavern—a small pocket that held the lives of the 33 Chilean survivors. Soon a note attached to the drill bit was recovered—“We are fine. …”

They were alive! But how to get them out?

By September 10, three different strategies had been devised—plans A, B, and C. Plan A called for drilling down directly from above—guaranteed to find them but taking months. Plan B would drill a small hole through the rubble of the twisting mine shaft and into a mechanical workshop that the miners thought they could reach. Finally, plan C would avoid the wreckage of the latest cave-in and take the shortest path, drilling some 1,900 feet to a bend in the mine shaft still high above the miners’ refuge.

Soon the rescuers were simultaneously pursuing all three strategies. But by September 17, plan A had stopped for maintenance of the drilling equipment, and plan C was still awaiting equipment and had yet to begin.

On October 12, in a plan B success, the first miner was brought to the surface through a 24-inch shaft that traversed a distance equal to almost twice the height of the Empire State Building. By October 13, all 33 miners were reunited with their families. What could have been a tragic ending was instead a victory of human ingenuity over the chaos of nature.

Planning for the unexpected

It happens all of the time: We plan for some goal, and life surprises us with something that thwarts our efforts at achieving that goal.

Since this is a common occurrence, those of us that try to prepare for life’s unexpected shocks always have a plan B, like the miners did, to deal with the unexpected.

These real-life stories have an investment moral. I think they should cause all of us to ask, “In investing, what’s our plan B?”

Buy-and-hold investing flies in the face of so many of the rules that we have learned should govern our actions in life. For example, most believe that working hard yields better results than just sitting back and hoping for the best.

It’s the ant and the grasshopper story from our youth. The ant works all summer, and the grasshopper whiles away the hours. Who survives the winter? Active investing seeks to emulate the ant; buy-and-hold investing, the grasshopper.

Similarly, we know that we should also have a plan B, no matter how good plan A is. But buy-and-hold investing has no plan B. You buy. If the economy prospers and the market rises, you hold. If the economy falls apart, you still passively hold.

If the market goes down 10%, you hold. If it falls 10% more, you hold. If it’s down 50% to 75%, like some stock market indexes in 2002 and again in 2008, you still hold.

An active investing approach, on the other hand, is responsive to the message of the markets. Like with the miners, it’s attentive to the tapping sounds—the signals that the market’s price action is constantly sending. And then it takes action to help rescue the present trade or to mitigate the losses.

We believe that, at its best, active investing does not follow the tenants of just one strategy. Buy and hold does not have a plan B, or a plan C, or any other variation. It’s just one approach. And you must live or die by it.

A more diverse, responsive plan B

In my experience, in investing and in life, following multiple active strategies offers the best chance to deal with life’s uncertainties.

Financial behaviorists have found that investors tend to see the future as a continuation of the immediate past. In other words, if the market has been going up for a while, most investors believe that it will keep going up. That’s why opinion polls of investors asking for market predictions at a market top are almost uniformly positive and mostly pessimistic at market bottoms.

This belief that, in the short term, the world will continue as it always has undervalues the amount of uncertainty that exists in the world. Investors underappreciate that change can occur at any time and that the change may not be predictable.

Unpredictable events, the so-called black swans of investing, can severely disrupt the financial markets. The lack of responsiveness to these black swans is a primary deficiency of buy-and-hold investing.

However, many might say that, by their very nature, these black swan events are unpredictable. So how can any strategy deal with them?

First, active strategies can change and respond to a new market environment that the black swan event may have created.

Second, we have learned in finance that one of the best defenses against uncertainty is diversification. However, in the past, financial advisers have limited that diversification to simply creating portfolios of different asset classes.

While that can help when the asset classes are truly diversified—like stocks and bonds are most of the time—what we have repeatedly learned from past market declines is that when a true financial crisis hits, all asset classes go down together. Asset-class diversification often does not help when you need it most.

As an investor, instead of diversifying only by asset class, you can diversify into different actively managed strategies. By doing so, you give yourself more options for dealing with whatever the market throws at you. Because some of those active strategies can go short or inverse to the market, you also have the opportunity to have a portion of your money working for you during a decline.

Strategy diversification is an essential weapon against uncertainties that buy-and-hold investing does not have. Buy-and-hold investing is like a football team with only one defensive play, a baseball team that only sends one fielder out onto the diamond, or a golfer who approaches the course with a single club in their bag.

What if the Chilean miners had used just one strategy to obtain their freedom? What if it had been plan A? Or plan C? Instead of the triumph achieved by also having a plan B, they likely would have experienced a tragedy.

As investors, our goal is to avoid such a tragedy in our portfolios. Making sure we have a plan B in our portfolios to turn to when a market bombshell explodes, turning prices savagely lower, can be the best defense. What’s your plan B?