Thursday, May 6, 2010

Every Now and Then …

Today was a reminder that every now and then the financial markets go nuts. In case you missed it, there was a major panic in the global stock market today. At one point the US stock market was down about 10% from its high of the day, but recovered to end the day down a bit over 3%. There were price swings (down, then up) of more than 5% within 5-10 minutes.

A Vanguard ETF (VEU) that tracks the non-US market had prices ranging from 40 to 34 within a 5 minute period (that’s almost a 20% difference!), ending the day down about 4.8%. There were even crazier swings in individual stocks, but you can read about that elsewhere if you’re interested.

It’s natural to feel fear when things like this happen. The parts of our brain that react emotionally and physiologically to perceived threats evolved long before the rational parts. It takes discipline to bring your rational mind to bear when your emotional mind doing the thing it evolved to do. With investing, it helps to put things in perspective, and remind yourself that investing in stocks is a long-term proposition.

In the last three days, the global stock market has fallen about 8.5% and the US stock market has fallen about 6.5%. However, even with this pullback, the global stock market is up about 75% from the low in March 2009, and the US stock market is up about 65% since then. Perhaps it will continue its correction for awhile, or perhaps it will turn around soon and continue its upward trend.  No one knows what the stock market will do in the short term, and you should ignore anyone who talks as if they do.

If you are adding to your investment in stocks, then a drop in stock prices gives you the opportunity to buy shares at lower prices. Especially if you’re young, you’re probably much better off if stock prices fall and remain low for years. This would allow you to accumulate many more shares, and in all probability the market will eventually rise, and you’ll end up with a much bigger retirement nest egg. So young people should feel exactly the opposite of the way we’re conditioned to feel when stock prices move up or down. They should be elated when they fall, and bummed out when they rise.

For those of us who are older, our asset allocation should be such that we can tolerate significant stock market losses without threatening our financial survival; i.e., most of us should have a relatively high allocation to fixed income (bonds and cash). If we’re lucky, we’re in the position to add to our stock positions when they fall in value, and probably will be better off if we have the discipline to do so.

Financial panics and bubbles have been with us as long as financial markets have existed, and there’s no reason to expect that this will change. Having an investment strategy, and sticking to it through the inevitable ups and downs is likely to be the most rewarding course of action in the long run.

1 comment:

  1. Wow I love the email feature! You should write a book about how to invest with zen principles ;-). I have a feeling my "panic" with this sudden crash may have urged you to write this article....but it is very much appreciated. All of us young investors should tape it on our walls as a reminder that a drop in the market is a good thing! ;-)