It’s time like these that tempt investors to act like traders. When the stock market starts to go down rather than continue its slow and steady plod upward there seems to be a behavioral shift and I want to walk through a few ideas. The first is that every investor thinks the worst-case scenario, “what if this is the next 1987 or 2008?” It is so tempting to try and time the market because you can easily see how even avoiding a day or two of 3% losses would quickly add up to significant gains. You need to resist the temptation because no one can consistently get the timing right and most people generally lose out trying. Even though the point drop is similar to 1987 the Dow Jones Industrial Average (DJIA) is at 16,000 and 17,000 rather than the 2,500 it was in 1987. Think on percentage terms, 500 points is a big difference then to now. To make the same percentage drop the DJIA would have to lose about 3,800 points in one day.
Corrections are a part of a normal market. So many investors find that statement disturbing but especially in our case now, we’ve gone years without even a 20% pullback in the market. The few short pullbacks we’ve had have all recovered just as quickly as they occurred. Over the long-term view a glance wouldn’t even pick up the blips. Right now China is dealing with the fact that their economy is growing slower than they expected (were hoping) and that in turn will impact global growth. The impact to global growth is revealing that market participants have been too optimistic on future earnings and growth. Those expectations need to be adjusted by selling those positions that seem clearly overvalued in a slower growing world. This is a good thing because it shows that market participants are not only looking at the next quarter’s results but taking the longer view and factoring in their future expectations into current prices.
Stocks go on sale when the prices go down. This is a great time to be able to buy stocks at prices that were available last year. When stock prices go down I will look at the stock chart and see the last time the market traded at that level. I remember in 2008 it was in the late 90s that the market traded that cheaply. That was nearly 10 years of earnings and returns that were discounted due to the concerns of the time. Even now while it looks like global growth will be lower than expected this is an opportunity to invest at a discount. All investing should be for the long term and good entry points are just a little more helpful. I don’t recommend waiting for them (timing) but as finances ebb and flow throughout the year and you have funds available it can be a good time to invest. I encourage buying when the market is on sale.
Stock market pricing theory suggests that volatility (which is measured and considered as risk) allows for higher returns over time. Almost every investor wants a steady growth of 8% from when they invest to when they need to start taking income but the stock market doesn’t work in straight lines. It has historically gone up on average, over time, with volatility, at about 8% but it is nothing like a straight line. The volatility is one of the reasons that stocks perform better than other investments. The theory suggests that investments with less volatility (risk) yield less return. The volatility (risk) is necessary to keep everyone from investing in the stock market, allowing those greater returns to those who are willing to accept the risk.
So remember these few thoughts as you lay down to sleep in a volatile market. This is necessary to a properly functioning market. You can also look at my post in July as well and see that a market crash is better than a market bubble for long term investors. Remember that investors have gone through much worse global market struggles (think war times or even 2008) and the stock market on a whole has recovered and gone on and up from there. Take the long view and you’ll be able to sleep well at night. Finally, as a note to those of you who think you don’t have so long to invest, if you are going to need to take all of your money out of investments over the next five years you probably shouldn’t be investing in stocks, consider this recent market action as a reminder why bonds are better for that. However, many of you who are taking income, you will likely need income for longer than five or ten years and therefore should consider stocks in your portfolio to exceed inflation and allow for your future income needs. Again don’t be anxious about these recent market movements. I recommend to you the popular again British propaganda slogan from World War II, “Keep Calm and Carry On."
