- Jonathan McCarty, CFP®
What to do when the market corrects.
Alright, who rocked the boat?
So it looks like, for the time being at least, the smooth sailing in the market has come to an end. Now is a great opportunity for us to talk about how we can react to the current market environment. This is really important:
How we react is directly responsible for how successful we'll be.
So, should we hunker down or is it time to jump off the boat? Let's start with the facts.
1) The market will always correct
2) We'll always have something to worry about
3) You can only control what is in your control
4) How we react during a correction directly impacts our financial success
I’m going to unpack these one by one. Now, by no means am I intending to sound like a Polyanna; rather, I’d like to bring some perspective and logic to a time that is frought with emotion for a lot of investors.
The Market Will Always Correct
First of all, I hate the term market "correction". What are we implying when we say that? Was it incorrect before? Is up the wrong direction? That feels backward. "Up" feels right; "up" feels correct.
Shall I propose some alternatives? Well, its my blog: how about a market "softening"? A market "exhale"? We could use some sports terms: the market "chunked its shot", its a market "air ball", or the market got "sacked"... ok, sorry, let's get to it.
If you’re invested in the stock market in your retirement or brokerage account (and that should cover about 100% of you), then you need to understand the ride you find yourself on.
We're not going up the mountain on a smooth locomotive with sturdy rails and a full firebox; you are riding piggyback on a mountaineer, and its possible that he's drunk.
At times, that climber has a nice patch of rock in front of him and he can move swiftly higher. Sometimes, the climber needs to pause and move sideways to find better footing or handholds. And, in times when all else fails, that climber will even have to backtrack a bit and look for a different path up the mountain.
It will never be straight-up-all-the-time in the stock market. Over the course of your investing career, the market will correct (probably several) times.
Check out the chart below from Bloomberg– it shows the yearly maximum draw-downs for the S&P 500 for every year dating all the way back to 1926. In laymen's terms, this just shows how painful it got over the course of each year - like how much the market was down that year at its worst point.
I’ll save you the time and sum it up for you: in 65% of the 90 years being measured, there was a double digit loss at some point. Furthermore, nearly a quarter of those double digit losses were greater than 20% losses. It's happened before and its probably going to happen again.
65% of the past 90 years had a double digit decline.
At least we’ll always have worrying
As human beings, we have to constantly fight the temptation to worry about things which are outside our control.
When it comes to the stock market, there have been countless times where I've heard the phrase “I’m worried about _________________, so I think the stock market is going to crash”. That ____________ can be many things: politics, war, valuations, interest rates, real estate, the President, Congress, China, North Korea, etc etc etc.
The market is an almost incomprehensibly-complex system; in no shape or form is it linear. You cannot explain or predict the market by saying that if "A" happens, "B" will result.
If we can jettison the Chicken-Little statements from your vocabulary, it just might help your emotional well-being when it comes to a market correction.
It's best to have a plan for how you’re going to react when the market corrects. Like, what are we actually going to do with ourselves? Are we going to suddenly become daily congregants of CNBC? Are we going to quit our job and go golfing because we might as well have fun before the world ends?
Make a plan for exactly what behavior is and isn't O.K. during a market softening (see, I think that term might work). Hopefully that plan includes limiting your consumption of the national news – you know and I know they are in business to win viewers and followers, and they do so by promoting hysteria.
When you start to see the “Dow Jones” ticker on the screen during your national news broadcast, that’s probably a good time to turn it off.
Things we can control
The market is random and beyond our control. It’s price movements fluctuate day to day and even the smartest prognosticator on Wall Street can't predict what tomorrow will bring.
So, again - in the aim of reducing our worry - let’s set that aside and focus on the things we can control. We can control having a plan.
Every person who is in the market, for whatever reason, should have an Investment Policy Statement (IPS). An IPS is a proactive plan.
Creating an IPS will help you set your risk tolerance, your time horizon, your expectations for volatility, return targets, etc. Major corporations and endowment funds all have an Investment Policy Statement, and so should you.
Other things you can control: how often you're saving, your investment fees & costs, what types of accounts to use, who you listen to and how you react or change your plan in response to market conditions.
So, how should you react? Well, if you have a plan, then you stick to the plan!
Maybe your plan calls for tactical changes? Maybe it's a buy & hold approach? Whatever it is, you (hopefully) made some smart, level-headed decisions at the creation of the plan. Now is exactly the time to follow that plan.
If you don’t have a plan, now is an amazing time to create one.
What’s the payoff?
So you might be saying “alright Mr. Smartypants, I get that you want me to stick by my strategy and not panic, but if I do that it might be painful. The market could go down more. What’s in it for me here?”
The payoff of sticking by your strategy is huge. It is directly responsible for your financial success going forward. Just ask anyone who bailed out of the market in 2008 and is still too scared to get back in; they’ve missed a historical bull market and, for the most part, they are the only people who still have losses from 2008.
The payoff by sticking with your investment plan is that, over time, the market trends upward. If we look back over the past 10-years, the S&P is up 142%, for an annualized return of 9.26%.
If we look back to 1973, the data is just as powerful: even the worst possible 20-yr period of time between 1973 and 2016 delivered an annualized return of 6.4%. The best possible 20-yr period delivered an 18% annualized return. Dana Anspach did a great job summing this up in the chart below:
If we let the short-term noise of the market distract us from our strategy - if you feel like bailing out of the market helps you avoid risk - please understand you’re just taking on another kind of risk: the risk of lost opportunity cost.
The folks who get out and stay out when the market chunks its shot (ok, that one is not as good) usually lose far more in lost opportunity cost then they would’ve lost on paper during the crash, assuming they had stayed the course. Again, find some of those 2008 ostriches and ask them; they're still around - I talk to a new one every month.
So, I realize that we all have a tendency to re-evaluate our position when we have stressful events like we’re experiencing now. While many of you should heed the "stick by your plan" advice above, it's entirely possible that many of you reading this are not appropriately invested.
Perhaps you should be more tactical and attempt to avoid volatility, or perhaps you should be less risky overall. We have crafted some amazing investment models to help tailor your investment program to match up with your ability to tolerate risk, and now would be an amazing time to get into the right strategy.
If you don’t have a plan or a strategy, please reach out and connect with me. I’d love to help.