Sunday, July 17, 2016

Y$10K - Don't Panic!

Reminder: I've set up a page to index the Y$10K blog articles. You can find it at$10K/. Articles are listed in the order written, so you can start at the top and work your way down if you want to catch up.
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I hope you've got at least a little money in the stock market by now. See my "Quick Primer on Investing" blog post. If you haven't started yet, you can get going right now. See also the post on buying advice within your stock account.

Again: Standard disclaimer. I'm not a financial planner. Blah blah blah.

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Today we're going to talk about the day you dread as a new investor: The day the stock market drops 10% or 20% all at once. (You never completely get over this dread, by the way.)

But you can prepare for that day by having a strategy. And when the day comes, you need to execute your strategy and NOT PANIC. Here are the key lessons from those blog posts that you have to remember when the market suddenly goes south:

1) On any given day, any given stock (or the market as a whole) can go down 10% or 20% or 30%.

2) The stock market eventually always goes up.

3) Don't track your stocks too closely.

4) Do not start "playing" the market.

These are extremely important when the market goes down. They will allow you to "keep your head" - and your money!

A Correction is Coming!

How do I know that? Simple: A correction is always coming. I personally suspect that we will see a correction before the November Presidential election in the U.S. due to the rise of uncertainty. But I could be 100% wrong. The correction might come in December, or in 2017 or 2019 or 2025.

Realistically, we will probably see a correction sooner rather than later. Why? Primarily because the market is at all-time high levels. The market has a tendency to "test" itself. Is this a bubble? Are these high prices based on reality, or on empty optimism? No one knows for sure until something triggers a sell-off.

Remember: The market as a whole is a large fiction. We believe Amazon stock is worth $750 or $800 per share because a lot of people are willing to pay that. If tomorrow people are only willing to pay $500/share, then that's what it's worth. We like to think a stock price is related to estimated future earnings, but sometimes it's just not.

So here's what happens: Some event or news triggers nervousness and stocks begin to sell. Why? Well, with the market above 18,000 they want to lock in their gains by converting to cash. Once enough people sell a stock, the price drops. More people sell now, worried that they'll lose money, and the price goes down more and more.

That's why you can't panic.

Most of the time, corrections such as this are tests. After a day or two, these stocks are simply considered "on sale" and people begin buying them again. After all, if I think Amazon is really worth $800, then I'm going to buy all I can at $500, $600, and $700. So now buyers rush back in, driving prices back up.
From, obviously

If you invested in a stock market fund that follows the DOW when I posted my blog in January, you bought the market at about $15,700. Today it's at $18,500. That's an increase of about 18%. Let's put that in perspective.

If you are hoping to gain 10% on your investment this year, you would expect about 5% every six months (without any compounding). So you might expect your investment to be at about $16,500 right now.

If there's a correction and the market drops ten percent from it's current price of $18,500 it will go down to $16,650. You'll still be ahead of where you thought you'd be!

If there's a correction and the market drops twenty percent from it's current price of $18,500 it will go down to $14,800. You'll be down from your purchase price. But you'll still have half the year ahead of you.

Remember the rules from above. Markets go up and down. But they always go up in the long run! So don't panic and don't sell when the correction comes.

Here's the simple formula that allows you to ignore your stock portfolio when a correction happens: Don't put money in stocks if you're going to need it in the next 1-2 years. Really. That's it.

Once you get enough money invested, a Certified Financial Planner will help you create a tiered approach to investing. So you'll have investments you expect to need in five years, ten years, twenty years, etc. From time to time, money will need to be moved from one tier to the next. Longer-term investments can be riskier because you have a longer time to recover. That means they have greater growth potential.

So if all the money in your stock investments is money you won't need for three years, you can sleep soundly at night when the market drops suddenly and recovers slowly.

The Good News About a Correction

Remember I said that a correction is a test to see whether the market it too high? Well it's also a test to see how solid the "floor" is underneath the market. The market might drop down and then climb a little, then drop down more and climb more. It will do this three or four times because investors feel confident that it just won't go down any more.

When that process is finished, it's literally like a climber who is convinced that his foothold is solid and he can begin climbing confidently again. Very often in this scenario, the climb can be very steep. So the reward for simply ignoring your investment is that it bounces up very well after the bottom of the market has been thoroughly tested.

Note on Volatility and Timing

Just a few quick words about treating the stock market like a game: Don't.

In all that up-and-down activity during a period of correction, testing, and renewed growth, some stocks will stay down for a long time. I remember when Xerox stock dropped dramatically in the mid-1990s and didn't recover for a decade. So individual stocks are pretty dicey for small investors.

You might be the smartest person you know about money and stocks. But if you're reading this, I assume you're not a financial planner. So there's no way you're going to out-smart the market. Most financial planners can't, and they do it for a living. By the time you figure out what the trend is, the professionals have either safe-guarded all their money or made big gains. You see the result of that and follow suit.

Making the "right" move one step too late will always leave you chasing the best informed investors. So don't try. That's just my opinion.

Final note: If there's a big correction between now and November, you may point to me and say I'm a genius. Or Google "Is a stock market correction near?" and say that I was stating common sense.

If the correction doesn't come, then look for one in the six months after that. Or the six months after that. It has to happen eventually. Whenever it does, you can say I predicted it.


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