No one knows enough to be a pessimist.
I love this line. It’s from Wayne Dyer, the speaker and author who recently passed away. Here’s another one I like:
If you change the way you look at things, the things you look at change.
These two quotes apply to investing decisions in today’s volatile markets. With some calm thinking and clarity about where you, you can avoid making poor decisions that may hurt you down the road.
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Where the markets stand right now
The S&P 500 is an index of the 500 largest stocks that trade in the markets. It’s a tool to measure the performance of the market as a whole. As of this writing (2/5/16), the Standard and Poor’s 500 Index (S&P 500) has declined nearly 7% for the year. That’s nearly 7% in about 35 days- which is unnerving.
So, the first step in making good investment decisions is to look at today’s market performance in the context of historical stock returns. Look at the annual returns of the S&P 500 since 1975, for example. I’ll round the returns to make it simple.
Looking the chart, take the two most recent market calamities: 2001 and 2008. The ’01, ’02 tech bubble bursting led to a 23% decline in ’02. That was followed by a 26% increase in ’03.
More market history
The mortgage crisis caused a 38% market decline in ’08. (I highly recommend The Big Short– an amazing movie that explains the crisis). That big decline was followed by a 23% increase in ’09 and a 12% increase in 2010.
Conclusion: While past performance may not necessarily repeat itself (The disclaimer you’ll see on investment firm advertising), we have seen markets come back from declines in the past.
We’d all prefer predictability
As I mentioned in this post, we all love predictability. Since we don’t live in an investment world that offers predictability, we need to make some judgments about risk. We face risk- how much risk is acceptable? Consider these factors:
• If you’re younger (20s and 30s) you have more time to recover from declines in the markets. You may be willing to take more risks- and invest more in stocks.
• As your investing time horizon gets shorter, you need more certainty in your investment performance. You may consider shifting a larger percentage of your investments into bonds. Bonds offer a fixed interest rate and a return of your principal investment at maturity.
• Understand the measurements of risk. I explain the concept of beta in this post. Beta measures the volatility of your individual stock or mutual fund, in comparison with the broader markets (like the S&P 500). Check the beta for your investments.
During volatile markets, you need to review why you’re investing, and what your time horizon is. You also need to monitor the beta for your investments.
How financial advisors are addressing these issues
Financial advisors are taking steps to remind investors of these concepts during volatile markets. Many investors are going the “DIY” route, when it comes to money management. I’ve mentioned Wealthfront and Betterment as DIY options in prior posts.
These two firms- along with other so called “Robo-advisors”- are blogging, emailing and tweeting to remind investors to take a long-term view of the markets.
There’s no getting away from the fact that investing in volatile markets is stressful. The unknown is stressful- and we all face it. Take some time, however, to remind yourself of why you’re investing, what risk you’re willing to take- and how markets have performed historically.
Don’t make a rash decision based solely on emotion. We’ve all done it- and sometimes we’re worse off in the long run.
As always, this post is for informational purposes only. Consult a financial advisor, tax expert or an attorney for specific advice.
Have used any of these ideas? I’d love to hear from you.
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
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Image: (CC) Wall Street Two Signs
Terrapin Flyer, Wall Street (CC BY-SA 2.0)