“The four most dangerous words in investing are: “This time it’s different”.”
~ Sir John Templeton
In case you hadn’t noticed, the U.S. stock market lost its cool this past week. First, it’s important to know that a correction was probably overdue. When it finally arrived, it came in grand fashion: this was reportedly the fastest market correction on record. A correction is when the market declines at least 10%, and this one happened in a mere six days. (Global markets were down, but my commentary is referring to U.S. markets.)
That’s all well and good, but what should you DO about it? The short answer is absolutely nothing at the moment.
The natural reaction is the wrong reaction
If you are invested in the stock market, you need to understand that it moves up AND down, and ideally, you need to be able to just look the other way when the downturns happen. The natural reaction, of course, is to panic and want to sell out of the market to prevent a further decline in your account. The idea there is to cut your losses.
That reaction, while utterly human and understandable, is completely wrong and will lead you to be a loser when it comes to investing. Literally a loser, not figuratively.
People who freak out will sell when the stocks have declined, and then wait until things seem “back to normal” and the market is recovered. Then they buy back into stocks. Maybe they even recognize this was a dumb thing to do and vow to never do it again. Nevertheless, the result is they sold low and bought high, which is the exact opposite of what you should do to be successful as an investor.
You haven’t LOST money in the stock market until you sell your shares when they are down.
Watching the values bounce around on paper is not losing money.
I’ll repeat that: you haven’t lost anything until you pull the trigger and sell low.
So, what is a person experiencing this natural human reaction of loss mitigation to do? As I said, if you have thus far resisted the urge to sell out in a panic, just sit tight. If you DID sell out in a panic, you might consider buying back in now, versus waiting for the market to rebound. That way, you will likely reduce the amount of value you lose.
An example to consider
Here’s an example using account values, not individual stock prices. Let’s say that prior to the 10% correction, your account value was $100,000. After a few days of down market, your account is now down 10%, meaning it is now worth $90,000.
Investor 1: You can’t take it and you fear further declines, so you sell your investments to cash. Now you have $90,000 in cash, and you are feeling pretty good about yourself, because what if the market continues to drop forever? (I should point out that this has never, ever happened.)
Investor 2: You recognize that it stinks that the market is down, but you remember that you don’t technically LOSE your money unless you sell, so you sit tight. This requires strong resolve, but it is the better approach.
Now the example continues. After a couple of weeks or maybe months, the market has improved. It has increased 15% from the low point of the correction.
Investor 1: You figure things are more stable now and “back to normal,” and thus you take your $90,000 and buy back into the market. Your account is, at that moment, worth $90,000.
Investor 2: You look at your statement and see that your account is now worth $103,500.
What happened to the $10,000 difference in Investor 1’s account? It is permanently lost due to selling out of the market when it was down. Investor 2, on the other hand, never truly “lost” anything.
What to do now, after the market correction
Now that the market has corrected, here are some proactive steps to take. This is assuming you did NOT panic sell last week:
Assess your feelings: How did you handle watching the market dive-bombing? Did you check your accounts obsessively? Did you bite all your fingernails off? Did you call your advisor six times? Or did you just let it ride, recognizing that the markets go up AND down, and this is all part of the process?
Consider your risk tolerance: If you were a Nervous Nellie last week, perhaps you need to consider whether you have the risk tolerance to be invested in stocks in the first place. Over long periods of time, stocks have proven to be the best growth investment. But that means nothing if you can’t sleep, you pull your hair out, and then you panic sell repeatedly. (Repeatedly behaving like Investor 1 above is why people are unsuccessful as investors, period.)
If a down-shift out of stocks or a reduction in the amount of stock is necessary, I urge you to do it over a period of months or years, not all at once. In essence, you want to dollar-cost-average your way out of stocks. (Read here about what dollar cost averaging is.)
Work with an advisor: If you are unsure about things, maybe you need a friend in your corner. Talking through risk tolerance and appropriate asset allocation (how your investments are divided among different investments) with an objective third party can help. Financial advisors, especially those that specialize in financial planning,* can also help you understand how investing part of your portfolio in stocks is necessary to achieve the financial goals you have. It’s always easier to stick with a game plan in investing if you understand precisely WHY you have the portfolio you have.
Pat yourself on the back: Holding tight when the market seems to be in free-fall is tough stuff. Kudos to you for recognizing that you can feel the fear and do it anyway.
If you DID panic-sell last week, see my above suggestion that you consider recognizing your mistake and buying back in as soon as possible.
What is next for the market
Could the market continue to move downward? Sure, it could! But eventually it will be on the upswing. And in all my years of managing investments, I know this to be true: swift declines are frequently followed by swift recoveries.**
My favorite example is the market drop after the terrorist attacks on 9/11. By anyone’s measure, the market had a harrowing drop following the reopening of the market after the attacks. What people don’t often realize, however, is that the market recovered to its pre-attack levels within thirty days. Thirty days, people! The stock market overall for 2001 was down. But we were in a recession that was preceded by a down market in the year 2000. The attacks were not responsible for the market being down overall in 2001, the recession was.
Thirty days, people!
Am I saying the market will absolutely recover swiftly after this correction? Shoot, no. If I were that good at knowing how the market would behave, I’d have fewer gray hairs and be living on an island somewhere as a rich woman. The fact of the matter is we have no idea how the markets will perform at any time. We can point to current events such as the Coronavirus outbreak and catastrophize how we think it will play out. But we won’t know until months or years afterward when, how, and why the market moved when it did.
Until then, it is guess-work. Even the pros are guessing, my friends. We can look at long-term charts of the market performance, however, and clearly see that over longer periods of time (typically ten years or more), the market goes up.
But the ride is never smooth. What would be the fun in that?
How did you manage the market volatility last week? Share below! Or if you want to start a discussion with some like-minded friends, join the free SimpleMoney Community on Facebook to share your thoughts!
P.S. If you like what you read, subscribe to our free weekly newsletter! This will keep you up to date on the week’s blog posts and podcast episodes, but also includes content only available to subscribers!
You might also enjoy:
*While I am a Certified Financial Planner™ practitioner, this is not a shameless plug. I no longer take on new clients, and I am actively moving into retirement from my planning practice. However, I can certainly vouch for the fine folks at the financial planning firm I founded in 1999. The firm is licensed in over twenty-five States and even counsels clients in countries outside the U.S. Tell them I sent you, and you’ll surely be treated extra nicely.
**Here is my general disclaimer to say that past performance is not always indicative of future performance and investing in anything carries risks. Do your homework and don’t just listen to talking heads or your Uncle Sal who claims to be an expert investor. Seek professional help when needed.