As we’ve seen in the opening weeks of 2016, stock prices are capable of sharp, erratic behavior. Whether these declines are the early stages of an eventual bear market remains to be seen. But even if not, such sharp pullbacks can be disconcerting to the average investor.
So how can you remain calm when the financial world periodically enters such periods of temporary insanity? Here are our suggestions.
- Remember that market downturns, while unpleasant, are a normal part of investing in stocks. Since 1962, the stock market has averaged one correction of 10% or more roughly every other year. (Of the 26 corrections since 1962, only nine went on to become full-fledged bear markets, with losses exceeding 20%.) It’s easy to forget how scary these declines are, especially when several years pass between them (four years passed between the 2011 and 2015 corrections). But take comfort from the fact they are a normal part of the stock market’s typical “two steps forward, one step back” progress.
- Understand that even severe bear markets aren’t insurmountable obstacles for long-term investors. The last two bear markets were quite severe by historical standards, so it’s no surprise that investors are fearful that a third bad one could be looming. But it’s helpful to recognize that for long-term investors following SMI’s investment strategies, even severe bear markets represented only temporary setbacks.
An Upgrader who stayed the course through the 2000-2002 bear market would have earned back all losses by August 2003. The deeper 2007-2009 bear market took a bit longer, but even then, Upgraders had broken even by April 2011.
Even more impressive, the back-tested results of SMI’s Dynamic Asset Allocation (DAA) strategy show that an investor following that approach would never have experienced a bear market (loss of 20%) in either period! See our February cover article, Resisting the Temptation of Market Timing, for more on how DAA can help insulate your portfolio from bear markets.
- Imitate the styles of the successful — avoid a trading mentality. Many studies have confirmed that an active buying and selling strategy is counterproductive for most investors. One study of 10,000 accounts at a major discount brokerage house over a seven-year period found that the stocks investors sold performed better than the ones they bought. Don’t assume you will improve your results by buying and selling in response to market volatility — studies have confirmed that improving results this way is a tough thing to do.
- Accept the reality of today’s financial environment — expect market turbulence. Volatility has become a permanent feature of our globally-linked markets. You must plan with this in mind. That means at least two things. First, diversify to lessen the impact on your portfolio when setbacks take place. Yes, there is a tempting potential for great profits when concentrating your money in one or two investments, but huge losses are also possible. By avoiding this temptation, you know that no loss will devastate you. Second, develop a long-term view that resolutely looks many years out, ignoring the news of the moment.
- Keep sufficient liquidity to meet your monthly cash-flow needs. Your standard of living over the next few years, which involves such things as making monthly mortgage payments and meeting routine living expenses, shouldn’t be dependent on how well the market does. Keep sufficient reserves in money-market accounts and short-term bond funds so you can afford to leave your stock-market commitments untouched for up to five years if need be. With a faraway horizon, current fluctuations need not concern you — you’ve got plenty of time for any selloffs to run their course. (See 3 Ways To Make Your Retirement Savings Last for more on this idea.)
- Focus on where you want to be financially in five to 10 years. Don’t become preoccupied with avoiding short-term losses. The important thing is that your portfolio mix is appropriate in light of your long-term personal goals. Many steps investors take to reduce the volatility in their portfolios involve lowering their commitment to stocks which, in turn, is likely to reduce their long-term returns. So, make changes only after much consideration of the long-term consequences, and make them gradually.
- Exhibit the fruit of the Spirit — practice patience and self-control. Take your cue from the Parable of the Talents where the master was away for “a long time” and make sure your strategy is a long-term one. This allows you to take up-and-down market cycles in stride. If you invest regularly, continue doing so regardless of market conditions. Your long-term dollar-cost-averaging will use temporary setbacks to your advantage.
- Remember your heavenly Father — trust His promises. “Look at the birds of the air; they do not sow or reap or stow away in barns, and yet your heavenly Father feeds them. Are you not much more valuable than they?. . . But seek first his kingdom and his righteousness, and all these things will be given to you as well” (Matthew 6:26, 33).