As they say, this drop in the market “feels” different. Stocks have been getting absolutely destroyed. So what’s an investor to do?
Phil Pearlman made a very sobering, yet truthful, statement in a post yesterday:
Sorry, no one can help you during a market correction.
As much as I would like to think that the correct perspective can help investors make clear-headed decisions with their investments, it only goes so far when things get crazy. Many times it all comes down to experience in the markets.
In the classic book Where Are the Customers’ Yachts, Fred Schwed summed it up this way:
There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here ever approximate what it feels like to lose a chunk of money that you used to own.
The problem is that it seems that with every new market decline, it’s like the first time all over again for investors.
As I explained last week, I find that writing on this blog serves as reinforcement for making better decisions for myself. I need to be reminded over and over again that making emotional decisions will eventually lead to terrible performance.
So what follows are some of my thoughts from the past year or so on how I think about or prepare for losses in the market. I wrote these when stocks were doing great as a reminder that the good times wouldn’t last forever. Nothing does. They might not be relevant to your personal situation or approach to the markets, but it’s helpful for me to review my previous thoughts to keep myself in check.
On who should be rooting for market declines:
In January, the last time stocks really took a fall, someone posed this question on Twitter: Which investors welcome the market decline?
My response in a post was: The first thing that popped into my head was ‘younger investors should welcome regular market declines.’
As with all financial decisions, personal circumstances will always dictate how beneficial a stock market sell-off will be for your portfolio, both now and in regards to your future savings. Of course, even though this makes logical sense, I still feel it every time stocks go down. It’s gut-wrenching to see the value of your portfolio fall even though you know that it’s a great thing for your future contributions.
Cheering for a falling stock market, even if it’s beneficial because of your time horizon, is always easier said than done.
Read More: How I Think About Stock Losses
On staying in your lane:
If you’ve stuck it out in stocks it’s OK to take a victory lap and pat yourself on the back. You’ve earned it. But stay humble. The market has a way of humbling those that become overconfident in their investment approach.
It seems everyone turns into a buy and hold investor when the markets are going up and a tactical investor when they’re going down. It’s easy to fall into the trap of claiming to be a long term investor in the boom times and a short term investor during the panics.
Remember this feeling when the market has a meaningful correction, because one of these days it will happen. It’s what markets do.
Read More: Remember How This Feels
On the value of a premortem over a postmortem:
With stocks continuing to take out all-time highs at a healthy clip now is a great time to think about these issues. Ask yourself what you would do under different circumstances to keep yourself level-headed if and when the time comes.
You can’t predict exactly which events are going to cause stocks to rise or fall. No one can with any precision. But you can predict what you will do if and when markets move one way or another if you have a plan in place.
Having a comprehensive investment plan is the best way to control your reactions because you will have rules to guide your actions depending on how the markets play out. A process helps avoid chasing past performance or trying to predict the future because it takes away the temptation to focus on outcomes which are mostly out of your control.
Read More: A Portfolio Premortem
On the role of expectations in risk management:
Within the framework of risk management it’s important for investors to have an understanding of expectations management. You need to keep your expectations grounded in reality when it comes to the performance of the various asset classes and your ability to handle risk in your portfolio.
Read More: Expectations Management
On preparing for a bear market:
It’s also important to understand your ability and willingness to take risk. Allocate more money to less volatile investments if you can’t handle losses, but understand that you will likely have to save more to reach your financial goals if you carry a more risk averse portfolio.
And for those investors that are in or approaching retirement, don’t have money tied up in stocks that you’ll need to use for spending purposes within 5 years or so. It’s too much of a risk that stocks could take a hit right when you need to sell if you have an all-stock portfolio.
For most average investors, a good rule of thumb would be to never own more stocks in a bull market than you’re comfortable holding during a bear market.
Read More: How to Preserve Capital During a Bear Market