Last quarter the markets took us on a wild ride. Even the ears of investors who don’t follow financial news perk up when the DOW plummets 1,000 points in a matter of hours.
Although a drop like this may grab your attention and flood your brain with doubt, you also realize that we have lived through even more serious pullbacks before, such as the 1987 crash, the tech bubble of the 2000s, or the 2009 financial crisis. Such events are difficult to predict; nonetheless, they are part of the financial cycle and will happen again. During these swings, the media further floods your brain with fear and doubt. Rational analysis is washed away by negative stories and images of loss and ruin.
Of course you know that at times like these you should just take a deep breath and stick to your plan. But sometimes, in a moment of doubt, a little voice inside asks, “. . . But maybe . . . ?”
For instance, when you read the headline: Greek Collapse Rattles Investors, you might think, “Oh, no! But of course we should stick to our plan. . . . But maybe this time is different?”
Or when you read: China’s Slow Growth Ravages Markets, you might say, “Yikes! But of course we should never try to time the market. . . . But maybe this time we can outthink it (accomplishing something that 99% of investors can’t do)?
Or if you hear: Will the Fed’s Decision Roil Markets? Of course you know that you have already built a well-thought out plan and a carefully constructed portfolio, based on your goals, with the highest likelihood of delivering success. But again that little voice tugs on your ear and says, “But maybe . . . I will feel better if I pull our right now and get back in when the market settles down?”
This uncertainty is one of the main reasons why investing is so hard. Even after you put in all the work to create and implement a plan, there is still more work to be done. Surviving uncertainty and volatility is an essential part of realizing long-term gains.
Another reason investing is hard is that we do not process gains in the same way we process losses. Loss aversion is a term coined by economists who realized that investors prefer to avoid losses even more than they prefer to incur gains. Psychologically, we process losses much more seriously than we do gains. The memory of loss can be very powerful emotionally, making the possibility of future losses something to be avoided.
And yet, when we invest, we need to accept the inevitability of short-term losses in any given year. Following is a chart that illustrates intra-year losses, followed by positive annual returns.
In any given year, the S&P 500 averaged intra-year declines of -14% from peak to trough. However, in 27 of 35 of those years the S&P posted positive returns, demonstrating another reason why it is so hard to time the market.
If we accept that markets are efficient over the long term and that pullbacks are an inevitable part of the cycle, we are more likely to keep calm and carry on (rather than listen to that nagging little voice saying, “. . . but maybe . . . ?”) and make smart decisions about our money.
All economies are cyclical. Markets expand and contract. Fat gets trimmed and innovation feeds new growth. Crises, slowdowns, and corrections are all part of these cycles, even if we find them disruptive in the short term.
So am I saying do nothing?
No. Review your plan before the year’s end. I believe that this process will provide you with friendly reminders and assist you the next time that little voice whispers in your ear, “. . . but maybe . . .?” And you will have the confidence to respond, “No way!”