Investing in the stock market takes discipline. Just when you think everything looks like smooth sailing and your portfolio is moving steadily higher, market volatility shows up — often out of nowhere — and calls your entire investing strategy into question.
But the one lesson that smart investors have learned — usually the hard way, through past experience — is that if you want to be successful in the face of market volatility, you have to fight your emotions.
Even though your knee-jerk reaction to the recent drops in the share market might be to sell everything and protect the rest of your assets, it’s not the right move.
Instead, you have to put the market’s decline into perspective and find ways to take advantage of it.
Hype versus reality
Most shares have seen marked declines from their recent highs. About two-thirds of the stocks in the S&P 500 have fallen at least 10 per cent from their best levels, and almost three in 10 have posted a 20 per cent drop — what some experts refer to as being in “bear-market territory.”
It’s easy for news sources to pump up investor panic with facts like these. But the reality isn’t nearly as dire, as long as you can get past the immediate pain of a big one-day drop in the share market and stay focused on your long-term strategic plan to build wealth.
Here are some things to keep in mind.
1. This is not a stock market crash
The most important thing to keep in mind about this week’s downward moves is that point-based declines can be extremely misleading. With the markets having climbed so far over the past decade, movements that used to be exceptional aren’t nearly as meaningful.
For instance, back in 1987, the Dow’s 508-point drop on what has subsequently become known as Black Monday seemed truly cataclysmic as it represented a nearly 23 per cent decline in a single day.
But even though this week’s drops were much larger in terms of points, the fact that the Dow is now above 25,000 means that it translates into just about a 3 per cent decline — a move that used to be a lot more common. Focus on percentages rather than points, and you’ll be able to assess market moves much more rationally.
2. These drops didn’t put a big dent in stock market gains
Given the way many talked about the decline, many people might have thought that their portfolios had been crushed. Yet even after an 832-point drop, the Dow was still up 880 points on the year, and the S&P and Nasdaq also remain higher year to date in 2018.
Here in Australia we’re not so lucky, given the S&P/ASX 200 index is down around 3.3 per cent so far in 2018.
And holders in popular stocks like Commonwealth Bank of Australia (ASX:CBA), Westpac Banking Corp (ASX:WBC), Telstra Corporation (ASX:TLS) and Ramsay Healthcare (ASX:RHC) will be licking their wounds, given their double digit falls so far in 2018.
There has been a shift the past 12 months into growth stocks, with ASX tech stocks now becoming increasingly popular with many investors and fund managers.
Although the Afterpay Touch (ASX:APT) share price slumped 11 per cent on Thursday, it is still up close to 150 per cent so far in 2018.
The Appen Limited (ASX:APX) share price was hit hard on Thursday, but it is still up 45 per cent so far in 2018.
If you had decided never to invest in these two stocks because you feared suffering big declines, you would indeed have avoided these downturns — but you never would have achieved these huge returns either.
3. In time, you’ll forget about the market’s drops
It’s hard to believe when the share market seems to be in free fall that you won’t always remember the pain that the drop caused.
But the share market has always bounced back from adversity, and smart investors take faith from that past experience and use it to make what seem to be bold moves.
You don’t even have to go back that far to see a great example of this.
In February in year, the Dow suffered not one but two declines of more than 1,000 points in short succession. Those drops were part of a broader market correction that eventually sent the market down roughly 12 per cent in less than a month.
Yet in less than eight months, the Dow recovered those losses and reached new all-time highs. In hindsight, what seemed like gargantuan plunges marked only a brief pause in the bull market.
4. Channel your inner greed
One of Warren Buffett’s most famous quotes advises investors to “be fearful when others are greedy, and greedy when others are fearful.”
Big market drops are the best time to follow the Oracle of Omaha’s advice by looking more closely at stocks that have suddenly gotten a lot cheaper to buy.
Build yourself a stock watch list for situations like this.
It’s tough to be unemotional in evaluating stocks after a big market drop, because short-term fears about a company’s immediate future are hard to ignore.
But if you’ve already researched a company and put it on your watch list, then it’s a lot easier to make the rational decision to add shares when a bargain opportunity presents itself.
Stay calm and prosper
It’s always tempting after a big drop in the stock market to take your profits and run.
The smarter, time-tested move, though, is to stick with your long-term investing plan — and for the best investors, that often means looking for attractive opportunities to buy promising stocks at cheaper prices.