Or: How To Stay Focused On The Long-Term Plan.
Depending on when you are reading this, the stock markets could be up or down on the previous year. At the time of writing, many of the major indices (Dow Jones Industrial Average, the S&P 500, etc) had recently seen some real highs.
But I want to talk about what happens when the markets start to slip.
Because that does happen. Markets go up, but they can also go down.
The thing is, when the markets have been moving up for so long, it is easy for the average investor to forget that at some point, sooner or later, they will see a drop.
And what happens when the Dow slips a couple of percent?
The media jump all over it, that’s what happens.
Doom and gloom!
The end is nigh . . .
And all these “experts” and pundits come out with their predictions, talking about corrections, bear markets and crashes.
Of course, while the number of retail investors in the stock market is relatively small compared with the high-frequency traders and institutional investors that make up the bulk, I still feel that the media does little to help the nerves of the average retail investor in these situations.
They’re great at getting behind a bull market and when we see a bit of a sell-off, they’re equally as efficient at proclaiming an impending crash. And it’s then a competition to see who can create the most sensational headline, because that’s what sells.
But remember: economies go through cycles and stock markets go up and down.
They go up and they go down.
It’s not always a one-way street, although that’s easy to forget while everyone’s giddy with stock market euphoria at the height of a bull market.
As I write this, it is too early to see if a major market correction has begun. But whether we see a drop in the markets or not this week, we are going to see a correction at some point in the future, so I thought this would be a good opportunity to share my thoughts on how to prepare.
Incidentally, for your information, on a technical level, movements in the stock market are defined in the following way:
A pullback is a decline of 5-10%.
A correction is defined as a decline in the stock market of greater than 10%.
A bear market is a drop of 20% from its previous high.
A crash is the sudden, dramatic decline across a significant section of the stock market.
It might just be a pullback, which is easier on the nerves for most of us, but even if nothing major happens this week, as I said, be prepared for the fact it’s gonna happen sooner or later, so consider the following:
1. Corrections are a normal part of the stock market movements
Pullbacks of 5-10% may typically happen 3-4 times per year and corrections are not infrequent either.
They are part of the natural order of the stock market and if you are a long-term investor, you’re going to see quite a few of them, so buckle up and don’t get rattled.
2. Don’t let emotions rule
Keep calm. Be patient. Fight your instincts. Stay diversified. The markets don’t go down forever and eventually they go back up. At least, that is what we have seen historically and we’ve only got that to go on.
3. You can’t time the market
Nobody can. Or at least nobody can do it with regular success. Sometimes people get it right, but these are usually the people that call a crash or correction every other month. As they say, even a broken clock is right twice a day.
Instead, stick to time in the market over timing the market. If you have a well-balanced portfolio that mainly follows the market indices, you’re probably going to be ok by sitting tight.
4. It’s sale time!
When quality stocks fall in price, view it as a great opportunity to buy up some more at a bargain price.
Psychologically, this is very difficult for a lot of investors to execute, simply because of the fear that the prices haven’t yet reached the bottom.
In order to overcome this fear, you need to ask yourself, “Would I have continued to buy more of the stock at the old, higher prices?”
If the answer is ‘yes’, then why wouldn’t you buy the same stock at the current lower price?
See #5 below.
5. Keep your eyes on the prize
If you are a long-term investor, don’t get spooked by short-term drops in the markets. These are only really an issue for short-term traders. Ask yourself, “Have the fundamental reasons why I picked this stock or fund in the first place changed?”
If the answer is “no”, then it’s crack on – as you were.
You can also look at this as an opportunity to review your holdings as a whole and make sure that the balance is in line with your overall risk profile and objectives.
Remember that whichever strategy you choose to follow, you need to factor in a there-will-be-a-decline-in-the-stock-market-at some-point type of approach.
So that’s my take. What are your thoughts on the matter?
Some more great posts on Expat Financial Guy.