Ever since spring of 2009, when the stock market started to recover from its biggest meltdown that most of us alive today can remember, a lot of people have been wondering, "When's the next big one gonna hit?" And the sharp downturns we experienced in February and then October of this year have only further stoked fears that "the big one" can't be far off. But there's a far greater threat to you as a stock market participant than a crash.
That threat is...(cue drum roll)... your own emotions. More specifically, your (and all of our) natural inclination to let our emotions make our investing decisions for us. Like cashing out of the stock market because we fear a collapse is imminent. Or even worse, cashing out after a crash has already brutalized our account and locking in those losses because we’re worried we’ll lose it all. And then not getting back in when the getting is good because we’re paralyzed with fear that the moment we get back in, another crash will drop on us. And that fear often doesn’t thaw until we’ve heard enough good news about how the market has done - but if we wait to get back in until then, we might end up being just in time for another downturn!
So, how can you combat this vicious cycle?
First, don’t look to news shows or financial media for guidance. Their job isn’t to make you money. It’s to convince you that you need to listen to them, and they do that by stoking your fears – both the fear of losing money and the fear of missing out on big gains that everyone else is enjoying. A good antidote to this is to subscribe to the free newsletter Big Market Trends, which I introduced in a previous post.
Second, accept that crashes are just a natural feature of the stock market landscape. (On the bright side, the market spends more of its time going up than going down.) But instead of worrying about when the next crash might be coming, decide in advance how you want to deal with it, and then follow through with that plan when the time comes. Would you rather just hold on tight and wait for the storm to pass, or would you prefer to work with a tactical system that uses hard data (not media hype) to help you (a) preserve capital when the odds of a crash are high (and possibly even profit from the crash), and then (b) go back to “business as usual” when the odds are good that a sustained recovery has begun? There’s no telling which approach will end up producing higher returns over your personal time horizon. For example, say that you plan on retiring (or being financially independent) in 10 years. If the next 10 years are like the 90s, then simply buying and holding a low-cost S&P 500 index fund/ETF over that period will likely perform better than a tactical approach. But if the next 10 years are like the first decade of the 2000s, then a good tactical approach will vastly outperform the buy-and-hold approach. So, to decide which approach is better, all you have to do is whip out your crystal ball and foresee how the next 10 years are going to go! Can’t do it? Oh well, at least you’re in good company; no one else can either. What you can do to move forward with a decision is to pick the approach you feel will be easier for you to stick with. If you choose to take a buy-and-hold approach but then sell out of panic when the market goes down by 50% or more (as it did in the financial meltdowns of 2000–2003 and 2007–2009), and then you find it hard to get back into the market again, then the tactical approach would’ve served you better. But the tactical approach requires you not to get frustrated and bail if and when it lags the market. Neither approach will work properly without emotional discipline on your part. So really, it comes down to a decision about which emotional discipline to develop: holding on no matter how low your account value goes, or sticking with the plan even when it’s up less than the market?
