The last five years have been a great time to own stocks and the market has bounced back and then some from the losses of the great recession. This year so far though has been a bit mediocre as overall stocks have stayed about even. Last Thursday and Friday the market suffered some of its biggest losses in the last two years.
All of this has led to a lot of speculation; the good days are over and we should expect stocks to fall this year as the market corrects itself. So are we headed for a market correction? Was Friday a minor blip and new highs are on the horizon? Time to buy or time to sell?
Storm clouds on the horizon
Investing in stocks is a little like owning a home in Florida. There are many benefits to living in Florida, but one thing you can pretty well guarantee is at some point in time you’ll probably experience a hurricane.
It is much the same when you invest in stocks. No one knows exactly when the next market correction will come, but just like the hurricane, you know it will come.
The question is how do you react?
Weathering the storm
No one wants to live through any hurricane, but not all hurricanes are created equal. A tropical storm or a category 1 hurricane is scary. A major category 5 like Katrina is terrifying.
Market corrections are the same. Sometimes after a sustained run of good returns, the market will go through a small correction and lose a few hundred points before bouncing back. Other times like we saw during the great recession in 2008 it can be much more catastrophic.
Regardless of the strength of the storm, the sun does shine again. Understanding that is the key to weathering the ups and downs of investing. Depending on the strength of the storm, the recovery may be more difficult. In a mild correction your investment may regain its value in a few months. In a category 5 like 2008 it took a few years. But in every case the recovery did happen.
Preparing for the storm
One key to surviving a major storm is preparation: Having a supply of emergency food. Perhaps having a generator in case the power goes out for a while. Some plywood to board up windows and a good battery operated weather radio. Having these things will help you make it through the storm.
By the same token, there are steps you can take to survive the market storms. Make sure you are diversified. If you are invested in one company and that company fails you will be in trouble. If you are invested across a wide variety of companies though chances are you’ll be in much better shape. In fact, some companies actually do better in lean economic times.
Another important key to handling these storms is having the right perspective. Investing should always be done with a long-term perspective. Today the storm clouds may be pretty black, but tomorrow the sun will be shining again. My 401K looked pretty scary in 2008, but in the years since I have recovered all that money and more. Having a long-term perspective means I don’t care what the market is doing today or next week or even this year. I care about what it will be doing over the next 20 or 30 years. With that as my focus the storm clouds of today aren’t quite as threatening.
Don’t panic when the storm hits
When the hurricane winds are blowing is not the time for you to try to make a run to safety. The day after the storm blows through is not the time to decide to sell your house because you can’t take it anymore.
Remember the only people who lost money in the disaster that was the great recession were those that got scared and sold when things were at their worst. Those who hung in there recovered all they lost.
That can be hard to do. I remember in 2008 and 2009, it seemed like every day there was another headline about how the market was collapsing. It was scary. There were times when I wondered should I just try to sell now before I lost any more money. I had confidence though that just as it always had in the past, the market would eventually recover, and that confidence has been rewarded. It takes a degree of courage though to hang in there when everyone around is yelling the sky is falling.
So is 2014 going to be a bumpy year for investors? Maybe. Certainly hasn’t been real great so far. But if there isn’t a correction in 2014, there probably will be one in 2015 or 2016. But regardless of how black the storm clouds get, there will always be sunshine coming on the other side.
Why do people live in places like Florida where hurricanes are a reality? It is because while hurricanes happen, they don’t define the weather. There are far more beautiful sunny days. They live in Florida because while those of us that live in the north are shivering through a polar vortex, they are thinking about putting on a sweater because it might get down to 50.
In the end I believe that one of the best ways to make money over time is by investing little by little in good well-diversified mutual funds. When you do that you can be sure there will be some storms you will have to weather, but over a period of years there will be many more sunny days.
Have you ever regretted an investment decision you made in fear?
Photo credit: Mrs. Gemstone (creative commons)