I was working through my personal mid-year financial evaluation this week, only to discover there’s been something close to panic in the global markets of late.
At least, that is, according to the media.
China’s stock market? The SHCOMP is down from a high of 3,993 to 2,964 at the time of this writing (08.25.2015), a drop of over 25% in just a couple of months.
How about Europe? The German DAX plummeted from 12,226 (an April high) to 10,128, a decline of 17%, while the UK’s FTSE shed about 15% over the same interval.
Then there’s the United States. Here, the S&P 500 has moved from an all time high of 2128 on July 20th to 1867 — nearly 14% off.
Everywhere I look on the internet, there are spammy ads to tell me that the worst is yet to come.
Whatever. This stuff doesn’t bother me in the slightest. Here’s how to cope.
Don’t Look At Your Retirement Account Balances
Sometimes when people notice broad declines, they become scared and make rash decisions. If your retirement strategy is anything like mine — buy and hold index investing — the best decision to make is none at all.
Remind yourself that you need to be exposed to the long-term growth opportunities the stock market provides. Short-term data isn’t particularly helpful when it comes to lifetime planning.
Suggestion: Remove that short-term data by not logging into your accounts.
Don’t Closely Follow The News
The media makes money riling up their viewers.
Scared and angry viewers are captive viewers; they need to know a) just how pissed off to be and b) what comes next.
Fact: A financial headline which catches eyeballs (e.g. CHINA COLLAPSE IMMENENT, U.S. STOCKS TO FOLLOW, COUNTRY TO RESEMBLE UPSIDE DOWN PORT-O-POTTY BY EOY 2016, LATEST) will also cause a certain percentage of their viewers to Lose Their Shit and sell. You get kicked into fight mode, at which point you feel like you need to take action.
Point? The national news engine does not have your best interests at heart and rarely helps people to become better investors.
Advice: Limit yourself to one article a week — or none at all if you find you can’t stop thinking about your losses. Read Mr. Money Mustache’s article about adopting a low-information diet instead.
Reminder: This Is What You’re Getting Paid For
Stocks are risky. This risk normally manifests in the form of market swings. The last six years — since late 2009!! — have been ridiculously calm, all things considered. It’s been basically a straight line upward to infinite wealth.
So what we have here is a long overdue break in the endless march higher, and a reminder to investors that stocks carry significant potential downside, particularly in the short term.
I can’t guarantee the markets will settle down and start moving consistently up from here.
But I’m am pretty sure that selling is the wrong move. Locking in your losses — with no coherent plan regarding how and when to get back in — is much, much riskier than staying in, IMO.
Look, either you believe in this strategy (indexing) or you don’t. This is hardly the time to make big changes. And if you can’t hang with a 15% drop, maybe it’s time to re-evaluate your risk tolerance and choose a different (more conservative) asset allocation.
Remember: You are earning a premium long-term return (relative to bonds, real-estate, cash, and gold) to deal with precisely this kind of
shit volatility. Deal with it.
So earn your money, folks — by staying the course and not panicking.
Stocks Are On Sale
A billion PF bloggers have written a billion posts about how when the market goes down stocks are on sale.
This means prices for U.S. ETFs are lower now than they were two weeks ago, which in turn means they are, by comparison, on sale.
Of course you already get this, so I won’t elaborate further.
If you’re still in the accumulation phase of your financial independence journey, consider using this as an opportunity to go and buy more of them.
Lower Valuations Predict Higher Future Growth
An extension of the point just above this:
Markets have values. They trade at a level above the current earnings of the companies which comprise them, based on the idea that they will continue to grow, earning earn more in the future than they do today.
The price-to-earnings ratio is one way to understand value a company, or an index of companies. (Tobin’s Q ratio is another.)
The higher the valuations, the lower expected future returns will be.
And the corollary is true as well: Lower current valuations tend to improve expected returns over the long term.
So with a P/E drop from 26.5 to 24.2, it’s true: You do have less money on paper. But since valuations are lower (price has suddenly dropped without a corresponding drop in earnings) you should be poised — in theory at least — to receive better earnings in the future.
Seriously, there is no spin here — this is a Good Thing to Happen for just about everyone who is still accumulating.
Nothing’s Really Changed
If you believed in your strategy six months ago, why mistrust it now?
I’ll make an assumption here: Since you’re reading this blog, you are interested in index investing or mutual funds. At the very least, you must believe in the market’s ability to grow — even dividend-focused (DRIP) investors think that the specific funds they pick are going to continue to rise in value over time, along with the tide of the markets.
But every investor knows that downs come with ups. This particular one may last a week or several years. In the end it’s just another market movement that you can’t control.
The latest drops — although reported as “unexpected” by the media — are actually completely expected in the context of long-term investments.
And expected events do not warrant changes when it comes to executing plans.
If Things Get Much Worse, The Government Will Step In
In one specific way, the U.S. government already has become involved — by (likely) not getting involved, at least for a while.
You may be aware that the Fed has been broadcasting an intent to raise interest rates sometime this year (2015). There are some indications that the backward movement of U.S. markets will force them to delay their planned increase. Generally when interest rates are low, money and liquidity are easier to come by, making growth more easily obtainable — albeit at the risk of inflation. All of this means that when interest rates are low, it tends to be easier for the stock market to rise — or at the very least, allowing it to stay at higher levels.
Another recent example: During the last major economic downturn, the government passed a (mostly effective) stimulus bill which helped to stave off the worst of the effects from the 2008 financial crisis.
And another: The Fed followed that up with their quantitative easing (QE) program over several years to further increase liquidity and buoy the economy and markets.
The broader message is that your elected-official-overlords want stock market stability and growth just as much you do.
In other words: The government is involved, and it’s here to help.
Remind Yourself How Much You’ve Already Made
Let’s say you had a million in invested assets prior to the correction, and you are 100% in U.S. equities.
After the 15% equity drop, your own assets are now closer to 850K. This is a staggering decline, no doubt. You’ve lost 150K.
But you have to remember: You made it to a million largely on the back of the ridiculous gains since 2009.
Let’s say you had 600K in the market in January of 2010, when the S&P 500 was around 1100. You haven’t saved a dime since. This would be worth about 1.127 million when that index hit its peak at 2067. You’ve earned 520K in the interim.
Now the S&P has come down to 1867. It’s true: you’ve lost over 100K.
But you’ve still earned over four hundred thousand dollars over that interval — despite the recent drops, the market has turned you into a millionaire.
Your glass of greenbacks is much, much more than half full.
Relax and focus on your gains instead of losing sleep over the recent downward movements.
Don’t Measure Your Losses in Terms of Time
Back when I was working, I used to play the following game:
I don’t need <thing>. I earn $40 an hour, after taxes, so that $400 <thing> costs me a full day in the office. I would much rather have a day of my life than <thing>, so let me put that money in the market instead.
This is a game you do not want to carry over to stock losses. If you do, it’ll become the most depressing thing you’ve managed to do to yourself since eating a full five course meal at Arby’s.
I just lost 100K in the market. It would take me 2.5 years to save that amount of money over my current living expenses.
Although perfectly true, that thought is an incomplete way to evaluate the situation. Again, you’ve likely earned quite a bit of dough from recent gains.
Although I lost 100K in the market, I’m still up 400K overall — it would have taken me a full decade to earn that 400K if I wasn’t in stocks.
See how much better that feels?
A Correction is Better Than a Crash
As you know know, relative to history, U.S. ETF valuations are high. Even mainstream news publications have cranked out a few articles on this subject.
I’d personally much prefer a 10-15% correction to nudge valuations back to something resembling sane levels to an out-and-out crash.
Because corrections are manageable. Everybody lives. Some of us grumble, but life goes on.
Crashes, on the other hand, come complete with panic selling and the utter ruination of the lives of millions. People jump out of buildings. Pension benefits are destroyed and people resign themselves to work until age 87. Companies decide to cut workers because their stock prices have dropped. Tough-to-break deflationary cycles materialize, screwing individuals and companies alike without discretion.
Nobody wants the mess that comes along with an out-and-out crash.
You Can’t Time The Market
This is another one you’ve heard before, I’m sure.
But it’s still true.
You’re Not Touching That Money Yet Anyway
If you’re still earning and accumulating, just tell yourself you don’t need to draw off those funds yet, so it really doesn’t matter.
Set your sights for further down the road and stop looking at the present day value.
Additional Notes for Retirees
It’s scarier to watch sudden drops in the market when you’re no longer working and accumulating. When you’re still earning, it’s no big deal: You just continue to throw money on the pile as you collect paychecks.
But when that torrent of cash is no longer appearing in your bank account every month, and you’re instead drawing off your investments, things look much dicier.
Here’s what I’m doing to make myself feel better.
1 – Reminding myself that it’s perfectly normal to have extended periods of time where my asset levels are below their levels at the time of retirement. In other words, it’s okay to have principal drops. Your retirement has by no means failed after a 15% correction.
2 – Thinking about the sweet, sweet loss harvesting that I might be able to do next year.
3 – Recalling my “Oh Shit Percentage.” (This is the level at which your assets would have to fall in order for you to actually take some form of corrective action in your retirement plans.) My own OSP is set to a 40% drop from the initial principal — it is around this point I will consider searching for full time employment. I also have a slightly less freaked-out Oh Crap Prcentage (OCP) which is set to 25%. At this point, if necessary, I will either a) scale back some non-essential spending or b) find just a bit of part-time work to help smooth things out until the scene looks a bit brighter.
Once you set these levels stop worrying about the markets and/or taking action unless those defenses are breached. Chances are very, very good that you’ll be fine. (Obligatory note: I am not suggesting everyone choose the same percentages I chose for myself, FWIW, but there may be value in assigning specific thresholds for yourself, in order to have a plan in place and restore a sense of control to your personal financial world.)
4 – I repeat the following: I am not my bank account balance. Higher numbers don’t give me a stronger sense of identity, purpose, or ego. Then I try to focus on other things, i.e. I Live My Life.
5- I am grateful for what my stash, however compromised, has already allowed me to do — escape my cubicle farm and chill the hell out for a while. Invoking gratitude is as simple as closing my eyes and picturing gray fabric walls surrounding me, then opening them again. When I do this, I immediately notice that IRL I am not in a box designed to contain humans any more. So, so good.
Look, I admit, when I initially saw the account balance drops I felt a pulse of alarm. I went so far as to ignore my own advice that day. I read a few articles about China’s stock market woes, issues in emerging markets, and the U.S. Fed’s interest rate dilemma.
But then I came to the same conclusion I always come to when I begin dipping into the nitty-gritty of global economic analysis: I can’t control any of this stuff and the deluge of data isn’t doing me any good. It’s not as though I rule the world (yet) or anything — I’m thankfully not involved in the process of directing world economies.
So yeah, I could spend the next 3 months as a nervous wreck, deep-diving into the specifics of the Chinese economic scene. I could engage in speculation as to how serious their own troubles are. Then I could use this information to bet on the market, etc, without having any guarantee as to the outcome.
But instead I’m just going to continue to follow the same ‘ol strategy I’ve been successfully employing for over a decade and a half, which amounts to sitting tight and not worrying.
The next time I will check my account balances will be mid-December, when I have the full scheduled yearly financial review.
With any luck, the results won’t compel me to write another blog post resembling this one.