The Best Trade Now May Be No Trade

I’m at a conference this week, and one of the presenters raised an interesting question about debt: “If you have a $1,000 balance on a store card and $10,000 on a credit card with a high interest rate, which should you pay off first?”

Mathematically, paying down the high interest debt makes sense because it reduces the amount you will ultimately pay in interest. But several people argued for eliminating the $1,000 balance first.

Their reasoning was psychological. Paying off one debt creates a visible result. You eliminate a payment, cross something off the list and see evidence that your effort is working. That small victory can provide motivation to continue.

In personal finance, these are commonly known as the debt avalanche and debt snowball methods. One prioritizes interest costs. The other uses incremental progress to reinforce behavior.

There isn’t necessarily one correct answer. The better choice depends on what you are trying to accomplish and which method you are more likely to follow.

The same principle applies to investing.

An investor seeking higher returns may accept more risk. Another may prioritize income or capital preservation. Problems arise when we judge one strategy according to the objectives of another.

That is particularly easy to do in the market, because we can always see what performed better after the fact. When stocks are climbing, a conservative strategy can suddenly seem too cautious. When volatility rises, the risk we were comfortable taking a month earlier can suddenly feel excessive.

Changing strategies in response to recent market behavior puts us in the position of continually reacting to what has already happened. This is one reason I rely on an indicator.

My approach is based on volatility and investor emotion. I’m not trying to determine what every headline means for the market or predict where a stock will trade next. I’m looking for specific conditions that indicate fear has reached an extreme and begun to fade. When those conditions exist, the indicator gives us a signal. When they don’t, we wait.

Opportunities are not evenly distributed. Some markets produce numerous signals, while others produce fewer. Increasing the number of trades by lowering our standards would defeat the purpose of having objective criteria in the first place.

A good strategy does more than tell us when to act. It also keeps us from forcing a decision when the conditions aren’t there.

That is what stayed with me from the conference discussion. Whether we are paying down debt or investing, we first need to know what we are trying to accomplish. From there, we can choose a strategy built for that objective and judge it by whether it is doing its job.

Markets will always give us reasons to reconsider our decisions. Clear rules give us a reason to stay focused on what we set out to accomplish.