There are two ways the crowd of market participants can be wrong. It can be wrong about the exciting stocks, and it can be wrong about the boring neglected stocks. The first creates a crash, while the second creates an opportunity.
The important point is that both can happen at the same time.
During a speculative boom, investors may vastly overestimate the value of fashionable businesses and severely underestimate the value of neglected businesses. When the boom reverses strongly, the relative valuation can change strongly. Suddenly, the investor who appeared foolish or idiotic for owning boring neglected businesses may look very sensible and smart.
This is why value investing can feel very uncomfortable before it becomes rewarding.
You often have to own things that do not look exciting and even, to some people, stupid. You have to watch other people make a lot of money in areas you deliberately avoided. You have to tolerate the possibility that they will make even more money in the short term. You have to remain intellectually independent long enough for valuation to matter again. That requires substantial psychological strength.
One Real Risk Is Permanent Loss of Decision Quality
Many discussions of risk focus solely on stock price volatility. That is an incomplete way of thinking about risk. For a long-term investor, one of the more important risks is losing the ability to make rational decisions during periods of excitement or fear.
Consider three investors during a speculative bull market.
Chases rising stocks.
Shorts the market because he believes a crash is imminent.
Gradually reduces exposure to assets whose expected returns have become unattractive and redeploys capital toward stronger risk-reward opportunities.
Investor C may underperform A for a while. He may also outperform A dramatically if valuations collapse. But more importantly, Investor C does not require a precise prediction. He is managing exposure rather than attempting to forecast events. That is often the superior structure.
A Quality-Value Investor Should Think in Ranges, Not Certainties
There is another benefit to de-risking: it allows the investor to admit and focus on managing uncertainty. The future of AI remains highly uncertain. The optimistic outcome is that AI will produce enormous economic value, with AI investment continuing for many years. Some current leaders may become extraordinary long-term winners, and some current hot stocks may eventually greatly disappoint. As investors, we do not know many of these things in advance during a technological boom rally.
The proper response to uncertainty is not necessarily to become bearish. It is to construct the investment portfolio so that several possible futures can be survived. That is where conservative valuation becomes powerful.
A range-based assessment will consider a bear case, a base case, and a bull case. The investor should then examine what return is embedded at today's price under each scenario. If the investment only works under the strongest imaginable scenario, the margin of safety is poor. If the investment works under the conservative bear case and becomes excellent under a much better bull case, the risk-reward asymmetry is much more attractive.
This way of thinking is much more useful than declaring “AI will win on a gargantuan scale” or “AI is a bubble.”
The Difference Between Volatility and Risk
A common 30% to 40% decline in a stock is emotionally painful. But the economic meaning depends on why it happened.
If an exceptional or great business experiences a temporary sharp reduction in market price while its competitive position, cash generation and balance sheet remain intact, the price decline may increase expected returns for a new buyer. If a stock declines because its business economics have permanently deteriorated, the decline may represent a genuine loss of value.
The two events look identical on a price chart. They are not economically identical.
Temporary reduction in market price while competitive position, cash generation and balance sheet remain intact.
A decline caused by permanent deterioration in business economics.
This is why the quality investor must constantly separate price risk from business risk. Long-only long-term investors should generally be more concerned with permanent loss of capital than temporary volatility.
Why Balance Sheets Matter More During Booms and Bubbles
During highly speculative to euphoric markets, balance-sheet strength can and will seem boring. Investors focus primarily on growth. Debt appears manageable because operating earnings are rising strongly, with interest coverage ratios seemingly improving over many quarters. Capital is typically cheap during such frothy stock market conditions. Customers are spending. Valuations are increasing. Management becomes increasingly confident.
Then the cycle reverses.
The cycle
During the boom
Debt seems manageable. Capital is cheap. Customers are spending. Valuations rise. Management grows confident.
When it reverses
Revenue growth slows. Margins contract. Financing costs rise. Customers become cautious. Inventory increases. Capex remains high. Cash flow turns sharply negative.
Suddenly, strong balance sheets matter. A company with little to no debt, high cash generation and strong liquidity has much greater capacity to survive difficult conditions. Financial strength is particularly valuable when markets become irrational, because the company is less likely to be forced into value-destructive financing or asset sales at bad prices. Companies with weak balance sheets may need to issue equity, borrow at expensive rates, sell assets, or cut essential spending.
Therefore, the same characteristic that seems boring during a boom can become extremely valuable during a downturn. That is the deeper logic of owning financially strong companies.
The Cost of Selling Early
There is an obvious counterargument: what if the investor reduces AI, technology and semiconductor exposure and these sectors continue rising strongly? That can continue to happen for months or even for multiple years. A quality-value investor has to accept this and the potential foregoing of very strong stock returns during the last speculative phase of a stock market boom or bubble. Prudent risk management does not provide perfect market timing.
The investor looks foolish and even stupid to some people, who believe the investor should have held or bought more of the stock at $100 a share. But perhaps the investor's valuation framework indicated that the $100 stock price already offered only a very low future expected return. The decision can still be correct even though subsequent stock prices were higher.
This is an uncomfortable but essential idea: good investment decisions should be judged by the quality of the information and rigour of logical reasoning available at the time, not only by the subsequent price path. Otherwise, every profitable sale of a stock becomes a mistake whenever the stock rises substantially afterward. That would make rational portfolio management impossible.
The Cost of Never Selling
The opposite course of action is also a mistake, and it is dangerous. An investor can become so attached to long-term compounding that he refuses to reassess business economics, management quality and valuation. The phrase “long term” can become a psychological shield against uncomfortable evidence.
It is investment-thesis attachment. Long-term investing does not mean holding everything forever. It means having a long to very long time horizon for business economics to dominate short-to-medium-term market fluctuations, while remaining willing to act when the investment thesis materially changes. The ability to sell is therefore part of long-term investing. The goal is to sell for the right reasons.
The Best Protection Against FOMO Is Having a Process
Investors without a process are easily influenced by the stock market:
The process-oriented long-term investor works differently:
Establishing valuation rules.
Tracking business economics.
Monitoring competitive positions of companies within their industries.
Reviewing management.
Examining financial statements.
Comparing expected return against risk.
Considering position size.
Maintaining a watch list of exceptional and great businesses.
Establishing criteria that would make the investor buy.
Establishing criteria that would make the investor sell.
This transforms investing from emotional reaction into rational decision-making.
The Most Valuable Thing to Own in a Crash May Be Your Own Judgment
When markets decline violently in a stock market crash, people often say: “I wish I had known this was coming and got out before it occurred.” That is very understandable. But it is probably the wrong objective.
“I wish I had known this was coming.”
“I want my portfolio to remain strong and resilient even when I cannot predict what comes next.”
That changes everything.
You do not need to forecast the precise date of a crash. You need enough financial and psychological resilience to survive one.
You do not need to know whether AI will outperform over the long term. You need to avoid making the portfolio primarily dependent on permanent AI outperformance.
You do not need to short AI, technology and semiconductor stocks. You can reduce your exposure to them.
You do not need to identify the next group of anti-bubble stocks perfectly. You can gradually build, over multiple years, a collection of boring or neglected exceptional and great businesses whose valuations provide very attractive prospective future returns.
You need to identify and sell where the reward no longer justifies the risk.
This is a much more achievable objective.
The Quiet Power of Doing Less
One of the most underrated investment skills is the willingness to do less:
Instead:
This sounds disappointingly simple. It is also remarkably psychologically difficult to execute.
The stock market during the workweek supplies numerous reasons to abandon patience. Social media constantly supplies screenshots of spectacular winners. Financial television consistently supplies a rapid pace of predictions. Online forums encourage speculation. Bull markets create FOMO while bear markets create panic. Every week appears to bring a new opportunity that supposedly cannot be missed.
The disciplined investor's advantage is therefore primarily psychological and behavioural: there will always be another opportunity waiting, one much more suitable to their own area of competence.