The last few months, but specifically the last few days or so have been very unnerving for many investors. Few of you may not know what I’m talking about, and as you’ll notice from below that is actually a good thing. We don’t want to touch on the details of ‘Why this is happening’ – as it really doesn’t matter, but very briefly is a combination of Chinese market/economy slowdown, combined with lingering Euro fears and Emerging Markets slowdown and topped off with Fed expectations of raising interest rates next month.
It doesn’t matter what the cause is, because stock drops like this are ‘designed’ to happen in the market, no matter what the cause is. I don’t mean we want them to happen, but we know from over a hundred years of history of markets that they do happen. We don’t really remember what caused all of them, but just that they did happen.
Now let's compare a ‘Bear Market or a Correction’ with a Real Grizzly Bear you may encounter at a National Park like Yellowstone. Below I’ve taken tips from a PBS article on what to do when you encounter a real bear, and I’ll compare that with a ‘Bear Market/Correction’. For reference, we call it a ‘Correction’ when the market drops more than 10% and a ‘Bear Market’ when the drop is 20% or more from the highs, but the below can be applied to stock drops in general.
- “If you encounter a grizzly, do not run”. – A Bear Market, or a significant drop should be treated the same. We cannot be faster than the market, thinking that we can get out before it happens and get back right as it’s coming up. Research shows that the worst days and best days happen almost next to each other and missing the best days really hurts our performance.
- “Avoid direct eye contact”. – In investing the less you look at your portfolio the better. Why? It is so, because we reduce the chances of looking at large losses and thus reduce the chances of making an emotional decision.
- “Try not to panic; remain as quiet as possible until the attack ends”. Panicking is the manifestation of fear and together with greed make up the emotional spectrum of a regular investor. This emotional investing has been overall very negative for investors, and for the last 20 years till end of 2014, the average mutual fund investor annual return was 5.19%, while the S&P 500 index was 9.85%/year for a difference of almost 5%/year.
- “While in bear country, be aware that you may encounter a bear at any time”. – Finally, understand that these drops are ‘by design’ and will happen time after time. For this volatility (the ‘belly pain’ we feel when we check our accounts) we are being compensated with a long term return of much more than cash or inflation. If that ‘belly pain’ is too large then you’re in a portfolio that is simply too risky for your appetite, and you should change accordingly.
In addition to these striking similarities, when we ‘make contact’ with a correction or even a bear market we should simply remember the facts:
- That stock markets, over the long run, revert to their mean – and, that long term average, from 1926-2014 has been over 10%/annual return for the S&P 500 index (Ibbotson Associates/Morningstar).
- “Since 1900 there have been 35 declines of 10% or more. On average the index recovered after an average of 10 months.” If your goal is longer than 5-10 years or more, chances of recovery are very good, even if we go into another bear market.
- Keep calm and carry on… Sure, advisors will say so, as it’s not their money you may say. But that is exactly the point. At times like this you need a rational, non-emotional source, to guide to the best path. Think of it as the doctor performing a surgery on a patient, while the patient’s family is waiting outside all emotional and worried. Do you want that doctor to be emotional as well or calm while performing his best. I know I would pick the calm and collective doctor and so would most of you. The advisor can remove the daily emotions and provide long term clarity that is best for your wealth (and health). This approach over the long run can add real percentage points return to your portfolios.
- Be opportunistic. The old saying of ‘Buy when there’s blood in the streets’ comes in mind, and it’s simply buying assets on the cheap, when everyone else is running. Of course that requires decent valuations, available cash and a ‘metallic stomach’, but many that do so during these times get rewarded generously for their initiative. It’s also one of Buffett’s tips for all of us, to buy when everyone is selling.
The PBS article concludes: “The recommended steps are not easy to follow, but they offer the best chance for survival.” – And that is exactly the same for investing in days like this or during any day that you choose to be invested; with investing you’re inside the ‘bear country’, so expect to see a bear or two time after time.
Lead Advisor, InvestEd.