How to Keep Your Head During Market Downturns When Everyone Around You Is Losing It?
I'm sure you know the feeling. The financial markets have started to decline, and you’ve invested in them. What you knew was an integral part of investing, but hadn't yet experienced yourself, suddenly happens – your portfolio abruptly starts losing units or low tens of percentages. The media is full of catastrophic predictions, and social networks are buzzing with the desperation of speculators who didn't get out of the market in time. However, you may also be on the "other" side and, after months of hesitation, wondering if it is finally time to get in and start investing. But how to do it without getting burned?
Petr Žabža | Investment academy | 27. May 2022
I've been in both situations many times, so I know that uncomfortable feeling in the pit of my stomach well. However, I've always been able to lean on a few basic rules to help me calm down and ensure that my emotions, however turbulent, didn't overwhelm my sanity.
What to Do or What to Be Aware of?
Volatility and occasional dips are part and parcel of the markets
The performance of financial markets fluctuates over time, being nothing to worry about. Firstly, because it is a perfectly normal phenomenon and, more importantly, because there is usually very little we can do about it. Market corrections (a 10% decline since the last peak) or bear markets (a 20% decline since the previous peak) are part and parcel of any investor's life.
Even a rising market experiences fluctuations, and it is not uncommon for indices to fall quietly by 10 to 13% within a year. A genuine bear market usually comes once every six years. I don't have to go far for examples:
- 2000 - The Dot-Com Bubble: Exaggerated optimism about technology and Internet stocks led to a 50% drop in the S&P 500 Index, which did not recover to its original levels until seven years later.
- 2008 - Subprime Bubble: An overheated US real estate market led to the S&P 500 falling again by almost 50%, recovering in five and a half years.
- 2020 - COVID: Amid general panic and uncertainty, the S&P 500 Index fell more than 30% in March 2020, bouncing back in mere six months.
Those who are prepared won’t get surprised
The worst thing you can do is deal with the situation after it arises. A time-honored rule of thumb is that you need to have a plan for both positive market development and a negative one – in both cases before entering the market.
Comforting yourself with "I'll somehow figure it out when it happens" is tremendously short-sighted. Because at that point, the aforementioned emotions come into play, making you likely to act irrationally.
When preparing your investment strategy, work with both possibilities (market growth and decline), planning steps for both cases. Taking shortcuts, recklessly and being exposed to media pressure, can ultimately bring you much more sizable losses than the market decline itself.
Know your brain. You'll know when it's trying to betray you
Homo sapiens share a part of the brain called the lizard brain with its biological ancestors. It is evolutionarily the oldest part of the brain that we indeed share with archosaurs. It bears responsibility for the survival of each of us as individuals, doing everything it can to protect us from any danger.
The risk of loss as a threat to our (financial) life is perceived very strongly by this part of our brain, and hence it automatically starts to prompt us to one of two reactions - fight or flight.
It can be very tough for an individual to fight the global financial markets. Therefore, the reptilian brain pushes us to flee (i.e., sell). And it doesn't care that there is a fierce battle between the rational part (which is developmentally younger and therefore weaker) and this reptilian brain in our head.
That's why many inexperienced investors sell their investments at the very bottom, as that is the point at which reason gives up its fight and the desire to "salvage what we can" wins. As they say, the pain of loss is perceived as twice as intense as the joy of gain. And no one wants to suffer voluntarily.
The second risk is the concept of anchoring, where we fix our mind on some portfolio value as the initial benchmark against which we then compare everything else. And it probably won't surprise you that we instinctively anchor ourselves to the highest value that our portfolio has ever seen.
If your portfolio was still worth €40k in February and is now worth only €34k, we view that as a loss of €6k. What does it matter that a year ago, for instance, it was only worth €28k, and five years ago, it was worth €20k? We are still "in the black" and unless we sell our investments, it is only a theoretical loss.
Diversify, diversify, diversify
No matter how often we repeat this word, it still won't be enough. What is diversification?
A naval analogy – if your navy consists of only one frigate and it gets hit below the waterline, your sailing’s over. But if your fleet is diversified, with frigates, cruisers, submarines, and a few dozen motorboats in addition to a few aircraft carriers, then sinking one or two ships - however unpleasant – is unlikely to be fatal to your fleet.
The same goes for investing. Keep your investments in different types of securities, in different currencies, and different areas of the world. As long as you have that - and ETFs are more than suitable for such diversification, as they contain hundreds or thousands of different stocks and bonds - a slump or even a failure of a few stocks can't threaten you.
The current correction has mostly hurt – and in some cases wiped out completely – speculators who bet on one card (one or a few positively correlated stocks or cryptocurrencies).
The evolution of some popular titles since the peak:
- Terra (LUNA) -99.99% (one of the once most popular cryptocurrencies)
- Zoom -84%
- ARK Innovation ETF -72.5%
- Bitcoin -54%
- Amazon -40%
- Tesla -38%
- S&P 500 Index -15%
Investments and speculations are two completely different categories
The father of all value investors (and Warren Buffett's role model), Benjamin Graham, has argued: "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
In the current insta-era, however, this subtle definitional distinction is often overlooked – to the great detriment of those who do so. Finax helps clients in this respect by clearly targeting and timing investments, having a broadly diversified and transparent portfolio, forming a healthy habit of regular investing, and limiting the possibility of "timing" investments.
Don't be afraid to ask for advice or another opinion
In times of heightened uncertainty and market volatility, it's easy to fall into "tunnel vision", getting locked in one type of reasoning and ideas – especially if you allow the media landscape to influence you (more on this below).
Don't be afraid to call your Finax Elite wealth manager (if you have one) to discuss your chosen investment strategy, diversification rules, and possible scenarios for future development. If nothing else, such a conversation can grant you a different view of events, enabling you to compare your thoughts and assure yourself that you're on the right track.
If you're not yet a Finax Elite client, we have a huge portfolio of freely available educational blogs. These will certainly serve you well in the aforementioned situation.
Schedule a 15 minute phone call for free
We will help you get started and learn more about Finax.
Be ready to enter the market and buy at favorable prices
Every situation can be viewed as a glass half full or half empty. Intelligent investors with a clear long-term investment objective welcome downturns, as they create an opportunity to purchase assets at "fire-sale prices".
However, you must not rush the decision and always consider whether you have sufficient cash reserves for unexpected expenses and if your standing monthly orders won’t get jeopardized by making such a purchase. You should only use a reserve that you have prepared for similar situations to make such extra deposits – which gets us back to investment scenarios and a well-developed plan for all situations.
Contrarily, What Should You Avoid?
Checking your portfolio too frequently
As long as you know why you're investing, have built your portfolio on a solid foundation, invest regularly, and don't abandon your investment goal, there's no reason to panic-monitor your portfolio's development several times a day. It's the equivalent of standing on the scale every hour while trying to lose weight.
Markets fluctuate and if you keep stalking your portfolio all day long, also stressing out due to the hustle and bustle on TV, web portals, and social media, you’ll greatly increase your chances of making an incorrect decision.
Remember that all media – whether traditional or online – follow one lesson: "If it bleeds, it leads". Their goal is to deliver the most dramatic messages and give them an emotional charge because that's the only way they can keep the viewer's attention. While you feel the world is ending, their advertising revenue is soaring.
Watch what you must, but don't let financial (or any) news coverage affect you for too long and too intensely, because then you may get a distorted idea of the true meaning of the event being described.
Thinking in a "what if" style
"Why didn't I sell last week when it was still high" kind of worry is completely useless. No one has a crystal ball and if someone's prediction of the markets is right, it's more likely to be luck and coincidence. You can't control the past, focus on your goal and look to the future. It may sound like a cliché but dwelling on the past is an incredibly unproductive use of your time.
Trying to time the market
Guessing the turning point of the markets may be a nice philosophical-intellectual exercise, but you should totally avoid it. Markets are complex mechanisms and even with the best will, none of us has all the information to objectively assess whether the markets have bottomed or not.
In times of high volatility, the markets are most prone to numerous false signals, and the likelihood that you will enter the market at an inopportune moment is close to a certainty. The only right way for an intelligent investor is to stick to your strategy and investment plan, invest regularly, and evaluate the events around you with a cool head and a healthy distance.
Do you have a tip or strategy that works for you but hasn’t been mentioned in our blog? Let us and other readers know, we'll incorporate it into the text.
So cheer up and, most importantly, keep calm and sensible!