I have some thoughts to share with you today to help you continue to be a better investor so you can live the life you’ve earned.
An unfortunate but true outcome during sharp stock market corrections is the transfer of ownership of a finite and fixed number of shares from those who were not prepared, and thus panic-sell out of fear, to those who were prepared and confidently buy shares at a significant discount.
You may want to pause and read that paragraph again.
Despite what the financial media and large brokerage firms convey, investing is not a reactive “market-oriented” activity, but a strategic and proactive “goal-oriented” process.
And, that goal-oriented process is based on market principles that we all have to keep at the forefront of our minds in order to avoid the common mistakes that occur during challenging market conditions.
- Markets work and they are working. Although we may not like the direction they take at times, the great news for all of us is that markets work even during crises, and information is incorporated into stock prices. We always have to remember that for every share of stock that is sold on a given day, there is a willing buyer on the other side making that purchase.
- Stock prices adjust to the point where a buyer believes they can earn a positive expected return from that point forward. Nobody buys a stock with the expectation of losing money.
Think of it this way as an example. At $100 per share, a buyer may not be interested because he or she may not believe the expected return from $100 per share going forward justifies paying that price. However, if the price drops 20% to $80 per share, there is a greater likelihood of the buyer earning the expected return they want to justify the purchase price.
- Stock prices are forward looking, i.e. expectations about the future have already been incorporated into the price. In today’s day and age, what are the chances that you know something that millions of other market participants don’t know about a company?
- Volatility is brought on by uncertainty. If there was no uncertainty, there would be little or no return, i.e. treasury bills. Your ability to deal with short-term uncertainty, and thus volatility, is precisely what allows you to earn higher expected long-term returns.
With those principles firmly in our minds, let’s now discuss one of the most common mistakes investors fall prey to during sharp market corrections.
“Why would anyone just sit there through a downturn in market prices and ‘lose’ money? Wouldn’t it make sense to just sell everything, wait for the dust to settle, and then buy back in after?”
Although nobody with this thought likes it to be labeled as such, this is classic Market Timing: the strategy of attempting to sell in and out of markets on a timely basis in order to avoid short-term losses and capture all upside gains. This stems from the commonly held belief, which is perpetuated by the financial media, that investment success is achieved by the few who are “in the know” who are able to successfully “navigate” in and out of markets at just the right time.
It’s sounds 100% logical in theory. Unfortunately, however, it doesn’t work in practice.
History is littered with proof that this belief is false. Noted Dartmouth Professor Kenneth French’s extensive research concluded that you would have had to be precisely correct on the sell and buy points 74% of the time in order to equal returns earned by continuously holding shares through all market cycles.
And, that a survey of famous market timers revealed that only a handful were correct more than 50% of the time, and the best was still at only 66%!
October 2007 to March 2009
History and distance from traumatic times have a way of providing clarity for future action. However, at first glance, that’s not always true with investing.
Now that more than a decade has passed, the massive market downturn we experienced over 18 months during “The Great Recession” from October, 2007 to March, 2009 appears to be a period that anyone and everyone should have been able to navigate in and out of successfully.
What we all forget with time, though, is that we didn’t experience that 18-month period of time in one instance. We experienced it one day, and in some instances, one hour at a time.
From October 10, 2007 to March 9, 2009, broad stock market prices fell almost 57% from peak to trough.
However, it was not a straight line down that was obvious to interpret and act on.
Experiencing Markets on a Daily Basis
Similar to what we’ve experienced over the last two months, during that 18-month timeframe, if you recorded market results on a daily basis, here’s what you would have experienced:
- Market prices closed up 46% of the days, and
- Market prices closed down 54% of the days
Isn’t that incredible! During the 18-month period of time when market prices fell over 50%, market prices closed up about 173 days (46%) and down about 202 days (54%).
I’m sure you expected it to be much worse than that with a much larger percentage of down days. (For reference, from 1973 through 2015, market prices were up 53% of days, and down 47% of days.)
So, as we experience markets on a day-to-day basis, that 18-month period wasn’t that different than the average.
What this demonstrates is that, when dealing with markets, our experience is never a straight line up or down.
Instead, it’s more like: up one day, down the next, down the next, up the next, up, up, down, down, down, up, down, up……
That’s how we experience markets, and that’s what makes market timing impossible as a long-term strategy.
Why Market Timing is So Hard
You not only have to make the correct call to sell out, and then to buy in on the correct days, but you have to make those calls at precisely the correct time during each day because prices change all day long. (And, because all asset classes behave and perform differently, you have to make those split-second decisions on each asset class you own.)
Just think of markets during the early stages of the COVID-19 pandemic where prices moved as much as 12% in one day!
Although it feels as if there was throughout time, there is never a clear and unquestioned signal in the moment when a decision must be made to sell or buy. Never!
That’s why buying into the belief that you can successfully time when to get out and when to get back in is so destructive to your financial independence.
Put It in a Drawer
After you have set aside five years’ worth of your anticipated withdrawals outside of the short-term volatility of stocks, i.e. in money markets and short-term fixed income holdings, and directed all dividends you earn to flow into your money market fund to support your lifestyle cashflow needs, the long-term solution with the rest of your Retirement Bucket™ is to remain globally diversified and strategically weighted across multiple asset classes during all market cycles with a goal of capturing the long-term higher expected returns each asset class offers.
And, then “put it in a drawer” and go about living your life.
Go ahead and pull it out of the drawer during pre-determined periods of time, i.e. once a quarter, half year, or yearly, and rebalance your holdings back to your originally prescribed mix.
However, as we have just highlighted, do not delude yourself into thinking that looking at it on a daily, weekly, monthly, or even quarterly basis will make you more knowledgeable, provide you with any signals to act on, or produce better results. What this allows you to do is remain confidently invested for the rest of your life knowing you will not be forced to sell your long-term stock index funds during a temporary market correction in order to provide needed cashflow to support your desired and well-earned lifestyle.