A stock market crash can feel like hell on earth. In times like these we need to look for wisdom of the highest order and a wise man once said:
“If you’re going through hell keep on going.” (Winston Churchill)
Maybe hell is a bit strong here, but then again when the balance of your hard earned savings is dropping like a stone and your job is on the line I can’t think of many better words to use.
Though it is often pretty clear what caused stocks to start dropping in the first place, it’s not quite as clear why they continue to drop and for how long. A chicken an egg relationship transpires i.e. stocks drop when people panic, but people panic when stocks drop! Psychology comes into play!
So are stocks dropping now because people are panicking or are people panicking because stocks are dropping?
No matter the answer, stock prices don’t drop without investors selling. In fact, for the kind of drops we’ve experienced recently, lots of people must have been selling, so the question then becomes does that mean you should too?
Let’s face it, it is hard not to. With each passing day, the feeling of regret that you didn’t sell the day before gets deeper.
On Tuesday you regret that you didn’t sell on Monday, on Wednesday you regret that you didn’t sell on Tuesday. By Thursday you are questioning your reasoning for investing in stocks in the first place. If it wasn’t for the fact that the markets shut at the weekend you’d have sold everything by Sunday lunch!
Thank god for weekends! Time to think long and hard about your investment portfolio.
And it is good to take a breather in times like this because things look a little different when you take your panic goggles off.
From an investing standpoint the world still looks very scary, but only in the short term. Yes, there are always naysayers out there claiming this time is different. This is the time where the world ends taking the financial markets and most importantly your investments with it, but a quick glance over the history books suggests that is highly unlikely to be the case.
Investing in the stock market is a long game built on a simple truth:
“Stocks markets go up more than they go down.”
I’m sure to some, that sounds like crazy talk right now watching your balance depreciate in real time, but the fact is, patient investors with a long term time horizon have been rewarded.
It is clear to see that even the simplest truths get forgotten in times like these when the psychology of markets takes over. If they didn’t, nobody would be selling their stocks, because that defies logic.
Stocks go up so why sell?
In fact, history shows stocks go up about two thirds of the time, leaving one third of the time for them to go down. In other words the stock market goes up about twice as much as it goes down.
I’m not a gambling man, but if somebody offered me odds of heads I win, tails I loose with a two headed coin, I’m gambling at every opportunity I can.
I’ve never seen a coin with tails and two heads. Normal coins are split 50/50, so whether you win or not is down to chance. On the other hand the stock market isn’t. Instead, the stock market is your two headed coin.
No matter what time period you are looking at, the markets are twice as likely to be about to go up than go down.
Just think about that for a moment. No matter whether you are talking about this afternoon, tomorrow, next week, next month, next year or next decade, the stock market is twice as likely to go up than down.
That piece of simple knowledge is all you need to answer some of the biggest investment decisions investors are facing right now. Questions like should I sell everything? Should I wait before I add more money? Should I drip feed a lump sum into the market?
And if you are talking about what makes sense financially and you want to shift the odds in your favor, the answers to all of the above are clear: No, No and No! Why wait when there’s more chance of the markets going up than down.
In reality, we don’t know what is going to happen tomorrow, next week or next year. Nobody does! On the other hand we do know markets go up twice as much as they go down. We also know that stocks recover.
Yes there have been some times in the past when they’ve taken a while and yes there have been some markets that haven’t recovered yet (Japan comes to mind) but if you’d had a globally diversified portfolio of stocks and a long term time horizon you’d have been just fine.
Even at the very peak of the tech bubble, investing in a globally diversified portfolio of stocks would have taken you just 4 years to start making money again, or about 5 after the Financial Crisis. And yes, 4-5 years for stocks to recover sounds like a long time, but it really shouldn’t for two reasons. Firstly, investing is long term game and secondly most investors should have bonds in their portfolio.
Just because it took a few years for stocks to recover, doesn’t mean it would have taken your entire investment portfolio a few years to recover. Bonds come into their own during market crashes.
Let’s be honest bonds are boring most of the time, but not when stocks crash. That’s because they don’t tend to crash like stocks do. Longer term government bonds have a tendency to go up when stocks are going down to cushion the blow. A globally portfolio equally split between stocks and bonds would only have taken about a year to recover after 2008.
To some investors the idea that it takes even one year to recover causes them to do silly things. They sell everything (after the markets have dropped) and stand on the sidelines waiting to get back into the market, but markets don’t ring a bell to say it’s time to get back in. Most investors either end up getting back at prices higher than the crash, or worse still never get back in at all.
Some investors just stay clear of the markets in times like these. Granted, staying out of the market is a step up from selling everything but it’s ironic really when you think about it.
Before the crash, when stocks were going up (and expensive) these same investors were more than happy to buy, but now those very same stocks are cheap they put everything on hold.
If you are investing for the long term stocks should be something you just buy whenever you have spare cash. You wouldn’t stop paying your gas or electricity bill just because the prices had gone down!
Even people with a lump sum to invest should seriously consider sticking it in the market as soon as they have it. Vanguard did a study (‘Dollar-cost averaging just means taking risk later’) which compared investing a lump sum with drip feeding money into the market.
They looked at different countries over lots of different time periods and found investing a lump sum trumped drip feeding. In fact, you probably won’t be surprised to find that they found that lump sum investing beats drip feed investing about two thirds of the time!
Without doubt some people would be better off drip feeding a lump sum into the market for psychological reasons. The negative feelings they would have if the markets tanked the day after they invested wouldn’t be worth the big gains they would get down the road. For those same investors taking time out during volatile times may make sense too, but I’d draw the line at selling out altogether.
If you really really really must sell just sell a little, say 5% or 10% of your stock holdings. That way if stocks go down further you’ll feel glad you did but if they go up you’ll be glad you didn’t sell them all.
For many investors out there (me included) investing spare money into the markets as soon as you have it should be the way to go no matter what is going on.
Waiting around for something we don’t know just doesn’t make financial sense. Why make investing decisions based on what we don’t know, when we could be making them based on what we do know?
To paraphrase a wise man (Winston Churchill):
“If you’re investments are going through hell, keep on adding money!”
As long as you are investing for the long term, are globally diversified, and have some cash for emergencies, somewhere down the road you’ll be glad you did.