Monday, February 8, 2021
Why People Hate Market Swings… And Why They Shouldn’t
Whether you are a first-time investor or a seasoned veteran, no one likes seeing their investments go down. It is a nasty feeling to have your hard-earned money lose its value seemingly overnight. Having been an investment manager for close to 5 years now, I am on the frontlines talking to clients when the markets dip, or even worse, crash. Part of my job is to help the clients when they first start investing to understand that it is all part of the territory. It is almost like the job of a coach, prepping their team for the big game. Sadly, the big game is a market downturn and subsequently the decline of their investment accounts. I wanted to get into the psychology of why people really hate when the markets swing and why they should instead not hate it at all. Let’s get to the bottom of this age-old issue once and for all.
Why People Hate Market Swings
It is confusing
The stock market is a very confusing thing. I watch market analysts debate for hours on end and none of them seem to understand it. There are fundamental principles that make it go up and down, sadly these principles are not present during certain market swings. The recent “Reddit Rally” is a case in point of that. A group of companies (GameStop, AMC, BlackBerry, etc.) stock was bought at a feverish pace without any sort of fundamental reason that they should be bought other than a bunch of people online decided it would be a good idea. Now the politics of the transactions can be debated for days, but the fact remains that those companies had done little to warrant their stock being bought at that pace. What the Reddit Rally did do was drive the rest of the market down. This was caused by the uncertainty and volatility this event caused. You see, markets thrive on certainty and flounder during uncertain times. Sadly, it is the uncertain times that brings out the worst in investors. It is the uncertain times that bring out emotion and it is the emotion that causes such great volatility. This occurs at a higher level, the Wall Street big wig, and especially at the lower level, the institutional investor simply trying to save for the future. It is only afterwards, often years later, that analysts begin to understand what potentially caused a drastic market swing.
It is scary
It truly is. No one likes losing money, especially money that was supposed to be for something as important as their retirement. Last March while we all were scrambling to find toilet paper, the markets proceeded to drop around 30% in a 3-week period. Yes, around a third of many people’s retirement nest egg evaporated in 3 weeks. That is terrifying for most people. The same thing occurred during the financial meltdown in 2008. When we are confused, like at a time where we can find something as simple as toilet paper, and our money is dropping, we get extremely fearful. The biggest fear is ALWAYS, “Will I lose all my money.” While we knew last March that the world was not ending, many of us did feel, and rightfully so, that the world as we knew it was ending, at least for a while. Coupled with confusion, being scared is a dangerous thing when it comes to markets.
We worry our money will be gone forever
One of my favorite movies is Casino, starring Robert De Niro. In this movie, the lead character Ace, played by De Niro, runs a casino in the early days of Las Vegas. One afternoon a millionaire from East Asia arrives hoping to try his luck at the Baccarat tables. He ends up winning a large sum of money from Ace’s casino which obviously does not sit well with Ace. In order to get the casino’s money back, Ace pulls out all the stops to keep the gambler in Vegas and not on a private jet back to his home. Ace knew that if the gambler kept playing, the house would eventually win. Sure enough, the gambler stayed and lost all the winnings back, plus millions of his own money. Now I hate to equate the stock market to gambling, but for some people it is. In this example, you are Ace, who owns the casino (the world economy). The people who jump in and out of the market are the gamblers who are trying to hit it big (day traders). As long as you keep playing (keep investing) you will win. The gamblers however must first beat lady luck, and then beat the hands of time to win. We often think of investing as a game or gamble. While it can be that, if done correctly, it won’t be that.
We don’t want to make a mistake
Throw in confusion, add in a little fear, all about your hard-earned money, and people worry that they are making a mistake. Is it a mistake to be invested at all right now? Is it a mistake that I have my money where it is right now? How long will it take to recover, or will it recover at all? The fear of making a mistake often drives people to make the mistake. It is the fear of doing the wrong things, at the wrong time. The adage “Buy low and sell high,” seems simple. The problem is us. As humans, we do not always do what we should and will often do things that actively harm us. This is a scary proposition, especially when our money is at stake.
A prolonged market period in which an investment has prices that rise faster than the historical average. Typically characterized by a stock market rise of at least 20% from its previous low.
A prolonged market period in which an investment has prices that fall. Typically characterized by a stock market that has fallen at least 20% from its previous high.
Why we shouldn’t hate market swings
Rebounds sometimes take time, but it is worth it
Every Bear Market in history has been followed by a subsequent and substantial Bull Market. When you think about it, doesn’t it make sense? The markets are falling and when they do it means there is a fundamental issue with them. This is often a systemic economic issue. Think the Great Depression, the Dot Com Bubble, and the Housing Market Crisis of 2008. You are not the only one who gets spooked when the markets get choppy. Large companies will often batten down the hatches when systemic economic issues arise, meaning they will preserve capital instead of investing for the future. This causes growth to stall and thus the market to stall as well. What results from this is a period of stagnation and intervention. Central governments will take measures to stimulate the economy to bring about growth and over time the companies begin to reinvest in the future. What results is a market rebound that can often happen quite quickly. The most prominent ones have all been followed by substantial rallies.
The Great Depression (1929): 2.8 years – Market Loss (-81.4%)
Subsequent Recovery: 13.9 years – Market Gain (+815.3%)
The Dot Come Bubble (2000): 2.1 years – Market Loss (-44.7%)
Subsequent Recovery: 5.1 years – Market Gain (+108.4%)
The Housing Market Crisis (2008): 1.3 years – Market Loss (-50.9%)
Subsequent Recovery: 11 years – Market Gain (+400.5%)
Even the massive 1987 stock plunge known as “Black Monday” was followed by almost 13 years of great economic expansion throughout the 1990s with over 800% stock market growth. History shows us that downtimes do not last and by making it through them we come out better on the other end. Dramatically better.
It means you are feeling the market
I want to preface what I say next with this: It is extremely important that you are properly invested. What that means is that you have a well-diversified portfolio based on funds comprised of solid companies who all have a long-term growth outlook. You and your financial advisor should both be working together to achieve this.
Feeling the market is important. I just mentioned that there are often sharp, fast declines in the market. I also mentioned that they are usually followed by prolonged periods of economic growth. Logically, if you feel the sharp, fast decline, then you will also feel the prolonged period of growth that follows. So my hypothesis is that in order to experience the pleasures of substantial, continuous growth, you must also feel the pain of sudden, dramatic declines. Yes, this means that you are “feeling” the market. Sadly, when the broader market declines it often drags down many company’s stock prices, even those that are not declining in revenue or growth. This is because of panic selling. The weak companies will falter over time, and the stronger ones will always survive. You want these declines because it means you will feel these increases over time as well. You should be more fearful of a portfolio that never moves.
It is an opportunity
I already mentioned the phrase, “buy low, sell high.” So, so, so, so, simple right? Then why on earth do many people NOT do this? Emotion. Sweet, sweet, emotion. No, I am not Steven Tyler. We have a natural instinct to shy from pain and embrace pleasure. The stock market is THE COMPLETE OPPOSITE. When things are bad, that is when you should be the most eager. We all love a sale. We should all love a market sale too. A 20% drop in the broader stock market should make you happy. It should make you excited. It should make you anxious to put on the trunks, break out the flippers, snap on the goggles, and get in the damn pool. We have already mentioned how steep market declines transition into prolonged market growth. Well if you are on the sidelines, meaning you have some cash to get into the market, a drastic market decline is your best friend. I speak about this in Step 6 of my Relevant Retirement System. Taking advantage of opportunities is what can kick your retirement savings into overdrive. My advanced portfolio, meant for long-term growth, averaged 15.72% in 2020. That included that drastic, steep decline in late March/early April when Covid hit us and subsequent recovery. I have a few clients that had the ability to add funds during that steep decline. Instead of the amazing 15.72% return that their portfolio would have received if they simply stood pat, several achieved upwards of a 35-40% return for the 2020 calendar year! Did they know where the bottom of the market was? No, they did not. Did they know how long it would take for the markets to recover? No, they did not. No one knew. No one at all. What these clients did know is that the markets were falling dramatically and it is a GREAT buying opportunity, so they got in. They used their resolve, and cash on the sidelines, of course, to take advantage of a momentary market drop and continue on with their long-term outlook. Cool, cool, cool. So damn cool.
When you sell, you crystalize your loss. Forever.
When you get out at the bottom of the markets, you solidify that loss FOREVER. That should scare you more than anything else. Sadly, most people worry about losing more portfolio value, more than they worry about not regaining the losses that they have already incurred. This is tremendously costly. When you buy high and sell low you cannot recoup the losses. You cannot take advantage of the subsequent rebound. You are out. You’re done. When you do want to get back in you must wait for another drastic decline, which sadly (or not so sadly) does not happen too often, or buy-in at a substantially higher valuation, which is terrible. A person I know took their workplace retirement out of the market after the Dot Com Bubble in 2000. They put those funds into GICs after that because they did not want to experience a drop like that again. If they had simply stayed the course their retirement nest egg would have been 4 times what it is right now. That one fatal move cost them hundreds of thousands of dollars. I wish I knew them back then. When you get out at the bottom, you seal your fate. That is a regret you do not want to live with, ever.
It is vitally important to have the right mindset as an investor. I am not speaking about the stock pickers or the day traders that operate throughout the daily swings and have to sweat that stress. I am speaking to the average person. The one who has a lot at stake. The one who worries about their kid’s education, their emergency savings, and their retirement nest egg. This investor does not play the day-to-day game so they need to drop the day-to-day mindset. When you are properly invested you will win if you have the proper mindset. This includes a long-term outlook and regular contributions. If it takes you NOT looking at your accounts regularly, then so be it. Some of my most successful clients NEVER look at their accounts. When the annual statement comes, they send a text saying, “good year eh.” If you get bogged down in the noise you will make the wrong move at the wrong time and it will hurt you dearly. I love being the middleman between my clients and their emotions. I am proud of that role. Investing is like hitting a baseball. You do not have to swing at every pitch. Wait for yours and knock it out of the park.
Joseph James Francis is a Financial Advisor and Money Coach based in London, Ontario, Canada.
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