Stock Market Advice: Don’t Panic!

Aug 31, 2015

Does a 10% drop in the stock market scare you?  Emotions lead to bad decisions.  Be a smart investor. Understand that markets go up and down and invest only if you have the wherewithal to stay invested while everyone else is panicking.    

It’s been a long time, but as we write this the S&P 500 has experienced its first correction since October 2011. A correction is defined as a drop in the market of more than 10%, but less than 20%. That nearly four-year period was the third longest rally without a 10% pullback in the S&P 500’s history. In other words, we were due for a correction. Now that it is here, what should investors do?

Don’t Just Do Something, Stand There!

Our first bit of advice comes from Douglas Adams’ classic tale The Hitchhiker’s Guide to the Galaxy, which is “Don’t Panic”. That is rule number one, because panic leads to emotional and often incorrect decisions.  This is the behavior that causes the persistent gap between a mutual fund’s performance and the performance of its average investor. Based on the historical data, an investor’s return is often lower than the mutual fund’s actual performance over a period of time. This is due to investors reacting inappropriately to a particular situation, causing them to buy high and sell low.  As we know, this is the exact opposite of ideal investor behavior.

Corrections are a natural and healthy part of markets cycles. Historically, corrections occur roughly every two years. Importantly, a correction does not imply that further losses are in store. It could happen, but it will not happen every time.

It is certainly tempting to sell in the midst of such market turmoil. Everyone who was invested back in 2008 remembers how it felt to watch the stock market fall over 50% in a five month period. However, after that horrific fall, markets recovered within three years. So it was a three-and-a-half year round trip. A general rule of thumb is never to invest money in the stock market if you are going to need it in less than five years. That allows you to ride out the inevitable market swings.

If you Sell, When Do you Buy?

The other aspect to consider is that if you do sell during a market downturn, you have a second equally important decision to make: when to buy back in. That is a very difficult decision. When the market bottomed in early March 2009, there were no blinking signs that read “Market Bottom! Buy Now!” The bottom was only apparent in hindsight and the bearish sentiment surrounding the market did not dissipate overnight. Even as the market began its recovery, there was no shortage of doom-and-gloom prognostications. To invest in stocks at or near the bottom meant going against the herd, which is never an easy move.

Taking a Long View

Investing in the stock market should be a long-term proposition. In times of market stress it can help to take a step back and look at the big picture. The day-to-day fluctuations of the market can seem huge, but if you look at a longer term chart, those daily moves are mere blips. The market marches upward over time. Not always in a straight line, but it does go up.

Plan, Plan, Plan

The best defense against market panic is to have a plan. Know before you begin investing what your goals are. Develop a plan that helps to achieve those goals. Brace yourself for the inevitable downturns. When they do occur, stick to your plan. Everyone would like to be clever enough to sell out of the stock market in order to avoid a downturn, but timing the market is impossible. Investors are better served when they can avoid getting into and out of the market frequently.

Summary

Market corrections are never fun, but they are part of investing. Investors should take that into consideration before they invest. Knowing about and planning for corrections before they happen will help ensure that investors do not panic. They can stick with their plan in order to achieve their long-term goals.

Schedule a Consultation

Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.

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