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It’s Been a Great Run, is it Almost Over?
U.S. stock markets are having one of their most volatile years of trading in nearly a decade. Now, some fear this long bull market may be on its way out.
If you are an active investor, you’re probably already familiar with these occasional dives. As history shows, sometimes these small moves can turn into a stock market crash, and even usher in a recession.
Stocks are just a partial ownership interest in a company. As a consequence of this, the stock market reflects investor confidence in the future performance of listed companies. Therefore a companies valuation will be a function of corporate earnings but may also depend not only on the objective health of the economy but also the perception of participants in the economy as well.
According to the former executive chairman at Templeton Emerging Markets, Mark Mobius, all the indicators now point to a recession in the market. He explains as “The consumer confidence is at an all-time high in the US, and it’s not a good sign – the market looks to me to be waiting for a trigger that will cause it to tumble.” While his prediction may or may not come to fruition, being prepared for increased volatility and a sustained downturn is a prudent thing to do.
How it Might Affect You
If a possible stock market decline happens, then what should you do to protect your investments? First off, don’t panic. It’s normal for the market to have ups and downs. This volatility often turns into panic and negative predictions from market analysts. However, a correction does not necessarily assure a broad economic depression. There are always economic developments and opportunities even in declining markets, whether they be domestic or abroad.
As Warren Buffett has said, “The stock market is a device for transferring money from the impatient to the patient.”
If you lose money in the market during a recession, it’s because of a decision you made — and if you make money in the market during a recession, it’s because of a decision you made. The market is going to do whatever it’s going to do. However, you determine whether you’ll win or lose. Looking back at 2009, selling all your stocks in a panic when fear was the highest was one of the worst moves you could have made.
What Happens to Your Long-Term Plans?
If the stock market takes a temporary dive into no man’s land, instead of panicking, you should ask yourself this question: “What has changed about your financial goals over the last year?”
Chances are, nothing has changed regarding your financial goals over the last year. So, why should a market downturn change the way you invest?
As the brilliant investor Warren Buffet says:
Someone is sitting in the shade today because someone planted a tree a long time ago.
In other words, to have success as an investor, you have to find an effective strategy for your long-term plans. Not for the next year, and not the following year. Planning for ten, twenty, or even thirty years should be your time horizon.
When you invest for the long-term, you should fully expect to win and lose some as the months and years pass. The only essential path to winning in the long-term is making sure you stay in the game long enough to make the most of the time when everything goes as you expected.
The important thing to remember is that typically the further off your goal is, the more risk you can tolerate to reach that goal. For example, if your goal is only one-year away, you probably shouldn’t invest in the stock market to achieve that one-year goal. On the other hand, if your goals are ten years away, tolerating the risks and sitting on an aggressive stock market investment makes more sense.
Be Careful About Your Financial Plans and Your Road Map
If you’re reading this article, it most likely means you have money socked away in retirement or a brokerage account. That’s absolutely great, but it might not be enough to give you what you want to achieve.
Most financial advisors would suggest you sit down to create an actionable financial plan that you can follow no matter what. Why? Because you need a plan to follow if you don’t want to be whipped around by the volatility of the market.
Think of your plan as a road trip through uncharted lands. With a map to follow, you will likely find your way through sooner or later. However, without a map, you might end up with a lot of false starts and wrong turns. Moreover, you may even end up far behind where you started.
The best part about having a financial plan is the fact it will tell you exactly what to do when the stock market tanks, which is usually nothing. A financial plan can help you see that even though there will be good days and bad days, the final trajectory of your investments is the only thing that matters.
Alan Lakein, the famous author on “How to Get Control of Your Time and Your Future” proposes the importance of financial plan as:
Planning is bringing the future into the present – so that you can do something about it now.
Preparing for market declines – What do experts say?
One of the most significant factors in an economic downturn is the potential for a rapid reduction in the value of assets. Many recessions begin with a big crash to the stock market, and often other markets – bonds, real estate, and other things – can also go through some painful declines as well.
Warren Buffet – Buy it and hold it
Market fluctuations create different opportunities. Buying stocks during recessions and holding for very long periods of time is one of the ways Warren Buffett has become so successful.
He often takes advantage of recessions, or one-off declines, by making smart decisions and holding the right stocks and properties. He explains the core idea behind it as:
Look at market fluctuations as your friend, rather than your enemy; profit from folly rather than participate in it.
Keeping a cool head and purchasing high-quality businesses when they go on sale is a valid strategy and it makes sense good sense. Buy low, sell high.
What does not make sense is to sell your stocks in a high-quality business because people are paying less for them.
Seth Klarman & Robert J. Shiller – Human behavior is to blame
The stock market is not stable because people are not entirely rational, no matter how we might try.
During a painful decline, this does not mean that the underlying businesses of the stocks we hold are fundamentally worth instantly less or more. It means our perception of those stocks’ value changes.
Respected investor Seth Klarman explains the physiological part of the stock market as:
The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.
Many declines are caused by human anxiety. Robert J. Shiller, an economist and American Nobel laureate, explains this behavior as:
This is an anxiety-driven world – the whole world is driven by anxiety. It is anxiety about the aftermath of the global financial crisis; it’s anxiety about inequality and about computers replacing jobs.
Paul Samuelson – Investing isn’t gambling
The U.S. stock market has its ups and downs from time to time. If you have the patience to endure the challenges, you shouldn’t worry. Contrary to popular opinion, investing is not gambling. Disciplined investing requires planning and patience. However, the gains you see over time, with the right plan, can be very rewarding.
The financial legend Paul Samuelson’ uses this analogy to explain the emotion you should have around your investments:
Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.
Sir John Templeton – This time it’s different
Each and every one of stock market recessions are unique for their times. Yet, they bring similar challenges. To cope with these challenges you should follow market trends and history. Don’t speculate that this particular time will be any different. For example, a major key to investing in a specific stock or bond fund during a recession is to look at its performance over the previous years. Past performance helps to predict future behavior.
In the words of investor Sir John Templeton:
The four most dangerous words in investing are: ‘this time it’s different.’
Benjamin Graham – The Stock market is a weighing machine
We should remember that stocks represent real ownership in companies; they are more than just blips on a colorful screen. Even though the market is irrational, if the company is performing well in the real economy, then the stock will eventually respond to that growth.
As Benjamin Graham famously said about the stock market:
In the short run, the stock market is a voting machine. In the long-run, it is a weighing machine.
So, if you already own stock and your business is growing convincingly, you might have to wait awhile, but eventually, you’ll get a fair price for your shares.
Ray Dalio – Greatest mistake of the individual investor
For many, the ups and downs of the stock market can be challenging and may lead to the common mistake of buying expensive assets when market confidence is high and selling cheaply when everyone is filled with fear.
According to Ray Dalio, an American billionaire and hedge fund manager, it’s a bad idea:
The greatest mistake of the individual investor is to think that a market that did well is a good market rather than a more expensive market. And that a market that did badly is a worse market – rather than a cheaper market.
The key to a successful investment strategy is having a plan and being able to stick to it. This can be easier said then done, especially if you’ve seen tens of thousands of dollars in paper gains disappear from your portfolio and be replaced by a sea of red. As the famous boxer, Mike Tyson once said: “everyone has a plan until they get punched in the mouth”–that is where sticking to your plan and having the appropriate time horizon for your investments is critical.
One of the most important quotes about investing comes from legendary investor Warren Buffet, who said investors should be
Fearful when others are greedy and greedy when others are fearful.
As described above, many of the worlds most respected investors leverage repeatable patterns in human psychology to avoid making investment mistakes. Ultimately, you need to determine your goals and the risks you’re willing to tolerate, but hopefully you can avoid some of the traps many individual investors find themselves in.
Note: CNote is not a registered investment advisor, and this information should not be relied upon as investment advice. Every financial situation is different and you should seek tailored advice to your specific financial circumstances.