How To Prepare for Investment “Accidents”

Apr 27, 2018

On April 17, less than an hour into its scheduled journey from New York to Dallas, Southwest Flight 1380 suffered an explosion in one of its two engines, causing shrapnel to pepper the plane’s wing and fuselage. The resulting smashed window caused the ultimate nightmare scenario: an open hole in a rapidly depressurizing plane, with passengers fighting to avoid being sucked out of the plane.

Unlike the “Miracle on the Hudson” in 2009, when pilot Chesley “Sully” Sullenberger safely landed his crippled US Airways plane on the Hudson River, saving all 155 people on board, Southwest Flight 1380 resulted in the death of one passenger. But the situation could have been much worse, and Southwest pilot Tammie Jo Shults (pictured above) has been widely lauded for her performance under intense pressure.

How do these pilots keep their wits about them in dire situations with so much on the line? And what can we learn as investors from these terrible accidents?

  • Be Your Own NTSB
    Air travel has become as safe as it is, in large part, because of the painstaking response to these types of events. When accidents occur, the National Transportation Safety Board swoops in and investigates every detail. If the problem is mechanical, new fixes are mandated. If pilot actions were partly responsible, new training procedures are created and put in place. One way or another, whatever caused that particular issue is identified and definitively addressed so the same situation doesn’t recur.

    Unfortunately, the precision involved in those meticulous investigative responses can’t be duplicated when it comes to the economy or investing. Air travel is governed by physics, where the same inputs produce the same results every time. In contrast, the economy and financial markets are not “hard” sciences. Sure, it’s possible to go back to a given recession or bear market and glean lessons from past experience. But those lessons are rarely ironclad — the next time around, investors may react differently to the same set of inputs. This is why economists can’t keep recessions and bear markets from recurring, even when they closely resemble past episodes. There’s too much behavioral variability involved.

    While there may be no way for an “Economic NTSB” to stop these episodes from recurring at a macro level, it is possible to intervene at a “micro” (individual/personal) level. Often, the mistakes investors make are behavioral or emotionally driven. For these, being your own NTSB can be remarkably effective. Identifying investment mistakes you’ve made and putting corrective measures in place can be a highly effective practice to keep you from repeating them.

  • Emulate The Pilots
    Faced with potentially crippling tension and fear, professional pilots manage to keep their wits about them. Recordings of their communications reveal remarkable clarity and steadiness. How do they do it? They train and prepare for these situations in advance, then rely on their training when disaster strikes. When these situations occur in the air, these pilots are able to respond cooly under pressure because they’ve drilled for those situations in simulators. It’s not the first time they’ve seen something like this. While they may not have simulated the exact situation they now face, part of their training has been, in essence, to repeatedly ask themselves, “How would I deal with ___?”

    This is a key technique we can emulate as investors. In fact, we have some advantages over pilots in this regard, because we know that many of the “accidents” we’ll face aren’t a matter of if, they’re a matter of when. Some of them, like bear markets, recur frequently enough that we’ll likely get to practice our response more than once!

    Asking yourself how you’d deal with various investing scenarios is a valuable exercise. SMI suggests the following three-step process for preparing for future trouble:

    1. Create a plan in advance — preferably in writing.

    2. Rely on mechanical triggers for future decisions. This eliminates making judgment calls under emotional duress, a sure recipe for failure. SMI strategies are built on such mechanical triggers, and some (like Dynamic Asset Allocation and Fund Upgrading) have defensive protocols already built in.

    3. Stick to your plan! Believe it or not, this is the toughest part emotionally. But drilling for these scenarios in advance will help prepare you to control your emotions when scary future events arrive.

Written by

Mark Biller

Mark Biller

Mark Biller is Sound Mind Investing's Executive Editor. His writings on a broad range of financial topics have been featured in a variety of national print and electronic media, and he has appeared as a financial commentator for various national and local radio programs. Mark also serves as Senior Portfolio Manager to SMI Advisory Service’s Private Client managed-account program and the SMI Funds.