How to Think About Market Downturns

I'll tell you what's happening: We've got ourselves another correction, doomie.

I’ll tell you what’s happening: We’ve got ourselves a correction, Doomie.

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.


2009 to 2015.  Tell me:  Where, exactly, is the freaking risk here?

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.

Don’t think:

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.

Instead think:

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.

Trust me, there's another way out.

If I was *really* Dr. Doom, I might be able to exert some influence on this here situation.  Alas, I am not.

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.

This entry was posted in CurrentLife, Finance, FutureLife. Bookmark the permalink.

40 Responses to How to Think About Market Downturns

  1. Love the Oh Shit and Oh Crap percentages. As I’m knees deep in the wealth accumulation phase, this “market correction” does not really bother me the slightest. I still have about 10 years until FI, so I’m happy to put my money to work at any prices, never mind “discounted” ones. Great job staying the course, per usual.

  2. sparkleb33 says:

    Having a bailout plan is good. I am in the retiree gap year stage as I have quit my job and am having some chill out time..I needed a break from the grey desk as I was going desk-crazy.
    I have read some of the news and although all this stock market fallout has resulted in loss reports on my spreadsheets mainly due to recent investments (which were made earlier this year before I quit the grey desk) I am not selling or getting into a panic. I can live for now so just need to ride out the storm.
    Worst case – I will have to go back to work. Yeh, I will struggle to get a job, the market is slow at the moment but I am sure I could find something.

    • livafi says:

      Thanks for the comment – hope you are enjoying your gap year.
      >>I am not selling or getting into a panic… Worst case – I will have to go back to work.
      Right, this is a good attitude.

      Funny enough, the whole “will have to go back to work” worst case seemed a lot worse to me when I was working than it does now that I am not. I think it has something to do with just how happy I am out of the office — even if I have to go back due to a complete meltdown or something, I will appreciate and value the time away. It’s been that nice, so far. 🙂

  3. Right on, man. Other than grabbing some silly stuff on sale last Monday, there’s a whole lotta “do nothing” going on in this house. Best way to manage your portfolio is do as you say – turn off the news and don’t worry about it.

    It worked back in 2008 and 2009, it’ll work again (even if this is the start of a significant market downturn). Lower prices = higher future return. And we need corrections like this to shake out overly optimistic expectations in the market.

    For young investors, this correction is the best news ever. They can get into the market at more reasonable levels compared to much of the last year.

  4. Doug Nordman says:

    There was a correction?!?

    Just kidding. But I also noticed that this month my investments still paid a dividend (actually a little more than last year) and yesterday my pension was still deposited in my checking account.

    And, more important news than any correction: Wal-Mart had a sale on surf wax…

  5. Mr. SSC says:

    I’ll have to set our own Oh Shit and Oh Crap percentages and strategy, those are a great idea. I’m sure they’re accounted for somewhere, but now, they have a name! 🙂 We had an automated investing snafu a few weeks before the correction and ended up not getting our usual amount invested. Then the correction happened, and we were able to get more stocks than if the snafu hadn’t happened. Win! Haha!
    We’re just wanting to get more stocks on the cheap before things start to get expensive again. Otherwise, it’s business as usual around our household.

  6. GreenDragon says:

    While this is all good info, what I want to hear more about is what you are doing with all of your free time nowadays. Like are you living in a log cabin in the woods yet? Thanks.

    • less4success says:

      Add a third vote for more Financial Independence Voyeurism 🙂

      • livafi says:

        I’m kind of working on a post to talk about some of the specifics but it reads a lot more like a teenager’s journal than a PF blog. I’ve always pledged to make an effort to keep this blog at least passingly related to the journey to FI (which for me was work+investing) and I’m not sure I want to go so far out of scope, to be honest.
        We’ll see.

      • less4success says:

        I totally understand and respect your desire to focus on the journey TO financial independence. You definitely have a unique (and insightful) take on preparing for FI.

        Just to clarify my line of thinking: there are some posts where you address preparations you made prior to RE (e.g. financial details, downsizing, and esp. envisioning a life without work) and I’m mostly interested in the view from the other side. Did your Life Without Work match what you had originally imagined? Is downsizing having the intended effect on your finances? Did you miss work? 😉

        For the record, I’m thrilled with the content you’ve already produced, so I will be happy no matter what you end up posting (or not posting). You’ve imparted so many nuggets of wisdom already that I’ll never feel disappointed with this blog–unless, perhaps you end up spewing Ramseyian “investment” propaganda to line your own pockets 🙂

      • livingafi says:

        I see, we’re talking about a slight scope increase with a direct relation to content which has already been produced; you want to hear about the results of theories, makes sense. I’ll keep thinking about it.

        This blog, btw, is not monetized and will not be unless blog hosting suddenly becomes expensive and it becomes necessary to cover costs. (Right now it is not – < $25 a year actually. A cheap hobby considering how many hours go into some of the posts.)

        Your Ramsey-comment made me laugh, thanks for that. Truth is I'm just not all that interested in the business side of it (blogging,) which amounts to cross posting on other peoples' blogs not because you want to actually leave a comment but because you're trying to draw more traffic to your own site, finding ways to market your own stuff, becoming worried about alienating advertisers, etc. Not saying there’s anything wrong with folks who do that! (People deserve to get paid for their work.) Still, it’s just not my thing. In a Jobs-Woz relationship, I would be Woz, implementing ideas, and getting boned by my more financially-aggressive partner.

  7. GoodPinkSlip says:

    These are good points. I’m early enough in the accumulation stage that my overall portfolio has officially lost value, so I can’t console myself with past gains – but the flipside is that the vast majority of my investment is yet to come, and now can happen at “sale” pricing. I plan on changing nothing, though the timing may work out such that I can increase my contributions a bit in the near term (which I would have done anyway, but now get to feel even better about).

    • livafi says:

      Don’t sweat it: After five full years of investing I was still underwater due to market losses. That’s a long time to go while looking at a negative return under your performance charts. But things turned around. Historically, at least, they always have. Just keep throwing money into your accounts when you are able and you’ll do fine.

  8. I learned something what was curiously absent from my MBA Finance classes: Oh Crap Percentage (OCP) and Oh Shit Percentage (OSP.) Crappy textbook…

  9. Mr Zombie says:

    Couldn’t agree more, just got to keep on trucking and ignoring all the gimpoids that raise their heads and say things like “I told you another crash was coming, I just knew it”.

    Too many people on the news sound like they know what they are talking about, and while they are mighty smart they are just speculating. Like you say, best course is to just ignore it.

    • livafi says:

      New word learned today: gimpoid.

      Your comment reminds me of a classic jlcollins post, There’s a Crash Coming. The problem is that these people are always right in the sense that eventually there will be another crash. But when? And how? We can’t predict these particular aspects of the answer.

  10. Fred says:

    Great post – I’ve just started my career and this market drop has wiped out all of my gains since I’ve started investing last summer (I’ve doing a passive index fund strategy that is so commonly recommended).

    I’ve also written a blog post on this, but you’ve explained this situation so much better and in a more complete fashion. Thanks! I’m glad I follow you.

  11. RB35 says:

    These recent events have illustrated the relevance of having some dry gunpowder that can be used to make hay when shit goes down.

    That aside, the serenity prayer is a pretty useful tool to reinforce the nagging inside out voices that might plague some of us mere mortals.

    Please grant me the serenity to accept the things I can’t control; the courage to change the things I can control; and the wisdom to know the difference.

    • livafi says:

      As a retiree, I do hold several years of cash, but not as ‘gunpowder’ to re-invest in the market but simply to spend so I don’t have to worry about pulling money out. I think the gunpowder idea — which I occasionally read about on forums — is akin to market timing.

      The serenity prayer is certainly apt – nice reference.

  12. “Where is the freaking Risk?” – exactly on the chart! P/E ratios are high, margin debt is an all time high, and typically procedes a crash. 2009-2015 is not a typical pattern, it is all QE fuelled and once QE is gone, watch out!

    • livingafi says:

      I agree to the extent that what we’ve seen over the last six years is not normal. Some amount of volatility is expected and it’s just not there.

      But to say that just because P/E is high this *predicts* a crash is wrong.

      Also, it’s not completely QE-fueled: a) Corporate profits have been rising and b) There are not great alternatives to stocks because interest rates and bond yields are depressed. Where else do you park your money?

      • Corporate profits are only ‘high’ because of share buybacks. It is all hiding the fact that baby boomers are near or at retirement and simply do not spend any more like they used to. No amount of government stimulus is going to change that. Look at Japan…. essentially 2 lost decades.

      • livafi says:

        Opinions, opinions.
        Look, I can’t say that I believe endless growth is a given. I can’t guarantee the US won’t have a decade or two of negative returns. I’ve read all about Japan.

        But my conclusion remains that buy and hold on US indexes is one of the better bets over the long haul. Not sure what your alternate investment strategy is going to be, holmes. If you know what the future holds, you should use it to get rich and write a blog about it.

  13. Dividend Growth Investor says:

    I agree, the best thing to do as a retiree is nothing.

    The best thing to do in the accumulation phase is to keep buying.

    Now get back to enjoy your retirement…

  14. Kenneth says:

    If you retired on exactly 25 times annual spend, it might be best if we get down to the 15+ percent range, to adjust your spend lower, draw lower. Are you drawing monthly or once a year? I have 3 years expenses in savings, which I plan to replenish once a year, unless stocks are down 20+ percent from peak, in which case I will stick at 2 years expenses in savings, then one year expenses in savings if necessary. IF we’re still down 20+ percent after 3 years, I’ll try to cut expenses, then draw monthly waiting for the recovery. One problem with the “FI Way” is that most of us have already cut expenses to a minimum, and used all the low hanging fruit.

    • livafi says:

      Ugh, sorry for the late reply on this but to answer your question: I draw yearly. I also hold 2 years cash in CDs and another year in a MM account for day-to-day expenses. The complete details of my plan are in the “drawdown” series on my blog – type drawdown into the search box and they’ll pop up. You could probably skip to the strategy post —

      Completely agree that it’s tough to cut if/when times get rough when you’re already running a tight ship. I found I could cut about 10% pretty easily but things hurt after that….

  15. beardeddragonfinance says:

    Well said. I’ve been reading a lot of comments in the financial blogosphere recently where readers are saying, “Shit, the market is down. Should I sell some stocks?” And these are people reading blogs that preach buy-and-hold investing. Just stay the course and let Mr. Market do his thing. Glad to know that you’re trusting your system. Enjoy continuing to plot world domination now that you’re free of the cubicle!

  16. dude says:

    When it dropped about 12%, I took it as an opportunity to re-allocate to a slightly more aggressive mix of 70-30, from 60-40. Had wanted to shift for a little while, but just couldn’t pull the trigger after the historic run-up in valuations. Now I can get back to just letting it ride with periodic adjustments back to target allocation.

    • Aperture says:

      dude – I had the same windfall – was overdue for reallocation from my bond index. Two weeks after the initial correction, I reallocated and picked up stock index on sale. Dr. D – it may seem like you are saying the same stuff that other sites have said, but I for one need to hear it again and again. My father worked his entire life and saved a fortune and invested it and should have been worth 10s of millions in retirement but was only comfortable because he watched the financial news constantly and moved his money around with every market shift. He did not have the advantages I have in the form of forums, blogs and a community of people that know which way is up.
      Thanks for your blog. -Ap

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