As humans, almost all investors are naturally inclined to follow tendencies dictated by our psychology. We extrapolate recent events into the future, and we are scarred by prior traumas. These reactions make total sense in some cases, but in the case of investing, they can ruin our financial future. The thinking that causes us to extrapolate rising markets as if they will continue to rise forever or extrapolate market declines as if they never end, goes hand in hand.
Remember Real Estate in 2005? So many extrapolated that this rising market would go on indefinitely. Or how about 2008? Yes, it was scary, and the decline was downright brutal. But did the United States “go out of business?” Of course not. Yet so many pulled their money out of the market only to see it rise for the next 7 years without them. So, yes, for the past 7 years, we have gotten to expect that markets go straight up, as they have done since March 2009, but the minute that we see any deviation from those expectations, we anticipate a market meltdown like 2008. The reality is though that the future doesn’t always follow such extreme examples. As a matter of fact, those extremes are quite rare. And, indeed, “extreme” is a word that can be used to describe both the disaster of the financial crisis ‘08 and the tremendous bull market that followed, of which both were almost without parallel.
In reality though, the market may be more inclined to follow a pattern seen throughout much of history. And that is one with more volatility than we have seen in the past seven years, and one that might neither go straight up nor straight down. We must recognize the tradeoffs that dictate the fact that with higher potential reward comes the necessity to undertake more potential volatility. And this market volatility often means losses from time to time in a way that is neither extraordinary nor necessarily predictive of any looming calamity.
Yes, there are positives and negatives in the world. But when are there not?
The economy grew at its long term potential growth rate, but even that was sufficient to provide for strong payroll gains during the quarter. The Fed hiked rates, indicated that it would proceed at a gradual pace, heartening investors who may have worried about rapid tightening. The drop in energy prices could boost consumer spending over the longer term, though early indications have been consumer’s preference for saving that windfall.
Global growth concerns, such as in China, could have ripple effects through the global economy; the strong dollar continues to be a strong headwind to U.S.; the sharp plunge in energy prices prompted a sharp cutback in capital spending by many energy firms and has had ripple effects throughout the stock and bond markets.
YOU ALWAYS CLIMB A WALL OF WORRY IN WALL STREET AND IT REALLY DOES YOU NO GOOD TO FRET ABOUT IT.
You always climb a wall of worry in Wall Street, and it really does you no good to fret about it. But I can instead offer a few questions for you to think about. Have you calculated or sat down with somebody who will help you measure the outcome of good and bad markets on your financial goals? I mean in particular, within the context of how YOU want to live? Not some generic, one size fits all calculator that you found on the Internet.
Can you or your advisor identify those areas of your finances that are in your control, and those that are not in your control? Knowing this is key to what to do if something out of the ordinary happens. Make sure this analysis includes an understanding of the psychology of investing, to help you make the right decisions, and help you understand what money really means to you and how money’s role in your life motivates you. In other words, does money represent the attainment of Happiness for you or freedom from Fear for you?
Also, in times like these, it is imperative that you recognize the human instinct to “do something.” This instinct ignores the most basic principal that we may be merely returning to an era of more “normal” volatility. And more volatility is indeed normal. According to research, stock market volatility over the last thirteen weeks is at the low end of the range of what is considered normal and typical. In fact, over the long span of time, the market experiences a decline of at least -10% once every 72 trading days on average; yet over the last 35 years, the US stock market has been up far more years than it has been down. So try to keep things in context. Doing nothing is also an action, and sometimes it is the hardest action to take.
Also remember that stock prices are daily quotations of the opinion of the value of very large businesses. These businesses’ actual value or intrinsic value is often something quite different than what is quoted on a daily basis. However, over time the share value will reflect the real value of the business. This is the way things work, and it’s important to always keep this fact in the top of your mind when making investment decisions.
So how are you doing, right now that the market is down somewhat from its high? The market is picking up in volatility, right? Some days there is fear in the market, and some days there is elation in the market.
What does Buffett say about fear and elation? He says: “Buy when others are fearful, sell when others are greedy.” I noticed he bought in the past few weeks. So which emotion is controlling you right now?