Take a deep breath…corrections are actually normal.
Don’t look now, but the panic of 2016 has begun.
So far this year the markets have been pretty ugly. It probably doesn’t help that 2015 wasn’t exactly a pleasant ride for investors. The year began with six months of pretty solid returns. But by the end of December, the markets had ungraciously taken back all of these gains, leaving most investors with less than they had 12 months prior.
Now, the markets are once again in sharp decline, mostly due to two factors: the weakening economy in China and geopolitical risk, exacerbated by an almost unprecedented drop in oil prices.
So naturally, like clockwork when the markets are having some bad days, the news media engines move full-throttle into doom and gloom mode. “Sell everything,” reads one hysterical headline on CNN. “2016 will be a ‘cataclysmic’ year.”
Remember this: It is never abnormal or out of the ordinary for the markets to experience dips and dives. They happen all the time. And once the markets turn back upward, it’s only human to forget about these corrections just as fast as they arrived. We tend to remember only the big ones, having been burned into our memories with the most recent global meltdown in 2008-09. It happened in such recent history, it is no wonder why most of us feel like it is coming again whenever anything negative happens in the markets.
The fact is however, that unless you are over 80 years old you’ve been alive for only one of those in your lifetime. Even when the underlying economic underpinnings are strong (unemployment down, consumer confidence up, manufacturing making a comeback), downturns and panic make for better headlines. As we all know, “Plane Lands Safely” rarely makes the 5 o’clock news.
So, are we headed for a big crash or not?
Colin Moore, chief investment officer at Columbia Investments does a good job explaining the major types of corrections investors can experience. In summary, a “normal” correction happens more frequently, can be small or large and for an extended amount of time, and can be very uncomfortable for investors to weather. However painful they are in the short-term, the result of the correction exposes the need to reduce growth expectations, causing a downturn in prices for a period of time, but also reduces the risk of extending what was previously excessive expectations that were built into the market, creating room for the market to move higher over time.
“Abnormal” corrections on the other hand are evidenced by a very severe sell off, prolonged, and driven by recessionary factors and structural damage in the financial system. These are very rare, and the recovery process can take years. (The news media doesn’t always know this distinction and helps fan the panic flames. On Wednesday, the Wall Street Journal sent out an alert: “Dow slides 364.81 points, entering ‘correction’ territory alongside Nasdaq S&P,” followed just two hours later with another alert, “Correction: Dow slides, but not into correction territory.” A correction of the correction.)
So as an investor, what should you do in confusing times like these?
A common reaction I hear is to “sell” and wait it out on the sidelines. But there are a couple big problems with this for long-term investors. In order to really benefit from getting out of the market, you need have almost pinpoint accuracy with the following:
- You actually have to be correct on your prediction. That is, the markets have to actually FALL once you sell.
- You have to return to the market at the right time. The bottom.
In reality, these are nothing short of impossible to accomplish. Unfortunately, most investors who pull money out of the market during these times tend to do so at the wrong time, and tend to reinvest only after markets have recovered. Many studies also show that missing only a handful of market up-days during a recovery causes investors to miss out on a good majority of those returns. A pretty vicious cycle.
I can tell you that the only surefire way of losing the value of your money (the purchasing power of your money) over the long-term is to leave it in cash. Over time, the terribly erosive effect of inflation is, by far, the biggest threat to your portfolio.
So if becoming a “market-timer” is not the way to go, what should long term investors do? Here’s my panic-proof to-do list:
- Stick to your knitting. If you and your financial advisor have a disciplined long-term financial strategy, momentary market events should not drive major changes in your portfolio. Only changes in your financial objectives dictate adjustments to the plan.
- Turn off the TV. You will be hard-pressed to receive good financial advice from the 24-hour talking heads.
- Don’t give in to emotion. Checking the value of your portfolio too often can be stressful, even during great market environments. Emotions can cause bad decision-making. Make sure someone (a qualified financial advisor) is watching your accounts like a hawk and remember that if you experienced great returns during good market times, you have to be willing to endure some of the bad.
Just remember Bette Davis line from “All About Eve:” “Fasten your seat belts. It’s going to be a bumpy night.” But that doesn’t mean it’s going to be time to panic.