How to Handle Market Downturns: Horror Show or Part of the Journey?
Stock market volatility — aka its ups and downs — is back.
Nearly two years into the pandemic, the coronavirus continues to impact our lives — and cause market volatility. Last week, global financial markets reacted to news of the omicron variant. By now, uncertainty surrounding changes in the world due to covid-19 is both new and familiar. After various pullbacks and market highs in previous months, how can you handle your investment portfolio — especially in these up-and-down markets?
You have two choices on how you can view periods of overall financial market losses:
First Viewpoint: You can visualize this stock market volatility as a villain, like those in these two examples:
In Poltergeist, the little girl warns, “They’re here!”
“Who?” you may ask. Well … stock market losses! AHHHHHH!!!
In The Shining, Jack Nicholson breaks through a locked bathroom door with his axe and then sticks his head in the hole sneering, “Here’s … volatility!”
Second Viewpoint: See your investments as a journey, like going down a mountain river.
You contributed to your investments at the top of the mountain (aka snowfall), and now your money is traveling toward your retirement years. There may be times when you experience some rapids, but you have faith that this journey will lead toward calmer and wider waterways.
Yet our human brains are programmed for us to remember the rapids instead of the gentle stretches.
For example, people are quick to remember 2008’s market performance. Can you easily explain the themes of every year between 2009 and 2017? Each of these years saw a positive year for the S&P 500 index, yet people always talk about 2008.
Volatile years with stock market losses are nothing out of the ordinary. Historically speaking, the last few years have been rare because we haven’t seen much volatility. This mellow stretch in the markets led to some investors getting overconfident and believing that the market always goes up.
Franklin Templeton Investments has a fascinating chart showing annual total U.S. stock market returns compared to the largest loss of the same year. 2017 and 1995 proved to be tied for the least volatile year in the last 30 years.
Know Your Brain: Loss Aversion
Psychologist Danny Kahneman won a Nobel Prize for his work in economics alongside his fallen comrade Amos Tversky. They conducted many studies, and Kahneman shared their findings in his book, “Thinking Fast and Slow.” One of their studies focused on loss aversion. They wrote, “when participants in an experiment were instructed to ‘think like a [stock] trader,’ they became less loss averse and their emotional reaction to losses (measured by physiological index of emotional arousal) was sharply reduced.”
Burton Malkiel explained it concisely in “A Random Walk Down Wall Street: The Time Tested Strategy for Successful Investing.” He said “Kahneman and Tversky concluded that losses were 2½ times as undesirable as equivalent gains were desirable. In other words, a dollar loss is 2½ times as painful as a dollar gain is pleasurable.”
Just like many behavioral finance biases, the first step to combat this trap is to be aware of the potential pitfall. No one likes to see their account values go down. Remember to think about how loss aversion may be influencing your investment behavior.
Long-Term Investing Inspired by Jack Bogle
Our brains are hard-wired to notice risks. Our fear of the unknown can program us to fight, fly, or freeze. Instead of defaulting to one of these survival instincts, think of a book title by Jack Bogle. Bogle, the founder of Vanguard and of index funds, titled one of his books “Stay the Course.”
Remember, the dollar value of your account is just a number on your computer screen. You haven’t lost any money until the day you turn that number into actual dollars when you withdraw the money.
My friendly challenge to you is to reflect on your overall investment goals, your time horizon, and the consequences you’d experience if you withdrew sooner than you anticipated.
To nudge you to reframe your thinking, since the market isn’t at an all-time high as of writing, it may be a good time to buy and contribute to your investments since you’ll be able to purchase more shares at lower prices.
You may already be doing this automatically through recurring deposits so you can Invest with Dollar Cost Averaging.
If this money in your investment account is earmarked as your “grey-haired money,” or funds you’ve set aside specifically for your comfortable future, then what would your “grey-haired self” want you to do in your situation? Think critically and make informed choices before letting your emotions drive hasty decisions during unnerving times.
Do you think your journey ahead will mostly be in rapids or on a steady river stream? You can’t control the markets, but you can control how you invest.
And to reference another horror movie: Just like in Birdbox, you can always put your blindfold on during the rapids and not obsess over checking your account value on a daily basis.
Want to Revisit Your Plan?
We determined goals for your investment account as well as your time horizon and your risk tolerance when we began working together. But this was just one step in your investment journey!
If you wish to revisit your financial plan, get in touch! We can send you a fresh risk assessment, then get together to discuss your results as well as any changes to your goals. Then, we can determine if a change in your risk tolerance indicates a meaningful and permanent difference in your appetite to take on risk — or if you were just temporarily frightened by that last rapid.
A Tribute to Jack Bogle: Jack Bogle passed away last year. He fought for the average investor when he created low-cost investment options by following indexes instead of paying investment managers’ fees to try and beat the markets. Warren Buffett praised Bogle saying, “Jack did more for American investors as a whole than any individual I’ve known. A lot of Wall Street is devoted to charging a lot for nothing. He charged nothing to accomplish a huge amount.”
Bogle’s index investing philosophy converted me a long time ago. You can read about it in this previous article: Passive vs. Active Investing: Keeping Your Costs Low.
To finish, I’ll share two of my favorite Jack Bogle quotes, which are fitting for this article’s theme:
“Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.”
“Time is your friend. Impulse is your enemy.”
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Photo by Phil Houston on Unsplash