I heard someone smarter than me say on a podcast recently, “We don’t react to the events in our lives. We react to our interpretation of those events.” He was talking about mental health and mindfulness. But that wisdom, which I think might be Stoic in origin, can also be applied to investing.
As I write this, the S&P/TSX is down 3% on the day. The DOW and S&P 500 are not much better. Year to date, the S&P/TSX is down just over 16% – dangerously close to the bear market territory that American markets hit a few months ago and after a brief rally, are testing the bottom of again.
Is this normal?
Yes. Every bear market is different, to be sure. We’ve never experienced this combination of a grinding pandemic, red hot inflation, and a nuclear super-power that threatens to destabilize a continent and, possibly, the world. But, as different as this may feel, the last 150 years has been an endless series of conflicts, disasters, and narrowly avoided catastrophes.
But through all of this, progress has been relentless and the stock market has remained the most effective means of growing wealth. As you can see from the chart, the stock market spends most of its time below previous highs (the red-shaded areas), and there are always compelling reasons to think it’ll drop further. But when it comes to investing, worry and opportunity go hand in hand; the best times to invest were also the scariest.
So, is this normal? Absolutely. Just look at more recent history. Since WW II, the S&P 500 has had twelve 20%+ drops, not including the current one.
We’re not wired for this
Logic is not enough though. We’ve all seen those charts of long-term stock performance a million times, but it’s hard to focus on the long term when prices appear to be collapsing. Human beings are wired to be short-term thinkers – it’s a biological imperative that served us well for millions of years . . . until we invented money, saving, and investing where long-term thinking rules.
Our biology is so maladaptive for good financial decision-making that we even have this quirk called “loss aversion” which makes us feel losses more intensely than equivalent gains. So, losing $1000 feels a lot worse than gaining $1000 feels good. In fact, most of us would have to gain 2 – 3 x as much as we lost just to get over the anguish. We are strange creatures.
Related: Coping with a market correction
Fees vs. Fines
It’s no wonder that on days like today, a lot of investors are feeling a little unwell because we forget how normal this is. One of the best finance books I’ve read in the past few years is “The Psychology of Money” by Morgan Housel. One of his many brilliant observations comes in Chapter 15, entitled “Nothing’s Free”. He says:
Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret – all of which are easy to overlook until you’re dealing with them in real time.
Housel empathizes with our discomfort but advises us to view that discomfort, not as a punishment that the markets dole out, but as the price we must pay to get access to the amazing long-term returns that stocks have offered. Volatility isn’t a fine for a bad investment decision, it is a fee we must pay to access higher long-term returns.
He goes on to offer sage advice:
The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.
Say you want a new car. It costs $30,000. You have three options: 1) Pay $30,000 for it, 2) find a cheaper used one, or 3) steal it. In this case, 99% of people know to avoid the third option because the consequences of stealing a car outweigh the upside.
Reminds me of the Napolean Hill quote, “The one who tries to get something for nothing usually ends up getting nothing for something.”
There are many professional and retail investors who are trying to reap the benefits of high returns without paying the price. It’s called active management. But the price must be paid and those who try to avoid it usually end up paying double.
Related: Why now is a good time to invest
Bear markets: don’t just survive – THRIVE
The good news is that we don’t have to be able to predict bear markets to be successful investors. Volatility is not a quirk of stock investing, it’s a feature. Here’s what we can do to thrive as investors in the stock market while paying the fee to be there.
- Convince yourself that the fee is worth it. Stop trying to game the system. Don’t try to steal the high returns of the stock market without paying the fee of volatility and uncertainty. Dig deep, change your perspective, accept it. It’ll be worth it.
- Pay less attention. Declines of 20% or more happen every few years. On any given day, stocks are almost as likely to be down as up. But remember loss aversion – we feel the drops more intensely than the gains and that often leads to bad decision-making. Avoid that behavioural risk by paying less attention to the markets.
- The power of planning. Watching markets and your account balance drop is nerve-wracking if your financial plan was not designed with volatility in mind. Having confidence that your financial plan is durable, suited to your risk tolerance, and capable of supporting your short, medium, and long-term goals is essential to successful investing through bear markets. (I love helping people build financial plans they can be confident in – feel free to contact me)
- Bullet-proof your life with a well-funded Liquidity Strategy. We know stocks are going to swoon on occasion, but they also bounce back. The time to recover from bear markets can range from 4 to 40 months. Having 3 – 5 years’ worth of cash, bonds, or GICs can allow you to ride out almost any kind of market conditions.
- Focus on dividend income, not stock price. Dividend-paying stocks have rewarded investors with higher long-term total returns with lower volatility, but one of the major advantages of being a buy-and-hold dividend investor is the behavioural advantage of being able to focus on the income that our portfolio is generating rather than the stock prices. Not only are dividend payments far more stable than stock prices, but the incentive to simply buy and hold to protect that income allows us to keep a level head during uncertain times.
By the way, if you are interested in building your own portfolio, you might want to consider using the same online brokerage that I use – Qtrade. They make everything easy to set up and have the best customer support out there. (If you use this link, I get a small commission that helps support this site).
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