What a wild year so far in regards to the market. We've seen volatility like we haven't seen since March 2020 which was the beginning stages of the pandemic. Today I want to discuss why you should actually embrace temporary market declines rather than fear them. I said temporary because they all are temporary and always have been temporary and will always be temporary. But the good news is:
Temporary declines pave the way for permanent gains.
What is actually happening in a market decline?
Let me be clear. I know these declines can be scary and unnerving to say the least and you wouldn't be a human if they didn't bother you. Sometimes they bother me too. However, please allow me to be professionally candid here. As an advisor, sometimes it's my job to tell you what you need to hear and not what you want to hear.
The media would like you to think lots of bad things. Lots of bad, bad things are happening and you should be very, very scared. All the "experts" are telling you how bad this could get and how this time it's different. This time is different than ever before and Armageddon awaits! I'm only one man versus mainstream media, but I'm here to tell you that's false and you should never be scared of a market decline. Never!
In a temporary market decline, stocks are returned to their rightful owners. That means the stocks of great companies that bad investors overpaid for during major market increases are now being returned to the wise and prudent investor at wholesale prices. Simply said, the emotional investor is panicking while the prudent investor is still buying. That's literally a simple description of the entire market cycle. And it also underlines a behavioral truth.
When an investor is reacting out of emotion rather than acting on a plan then failure is inevitable.
What can we learn from temporary market declines?
The wise and prudent investor is excited to take advantage of falling prices and therefore rising values on the greatest companies in the world. Meanwhile the emotional investor flees from them in terror proclaiming this time it's different! The prudent investor perceives this as a giant sale on the great companies in America and the world while the emotional investor perceives it as the long awaited Armageddon.
Notice that they are both experiencing exactly the same thing but they are processing the experience in opposite ways. What can explain this?
Human nature is immutable
Human nature never changes. We can go back to the days of Adam and Eve and emotionally speaking, we aren't any different then they were. And as long as human economic actions are dictated by human nature then the same things will happen over and over again.
In an "up" economy people will borrow too much money to finance things they can't really afford. Investors will overpay for the next big stock that will get them rich quickly. The economy will grow beyond its sustainable capacity and stock prices will do the same.
Then, in a "down" economy when loans default, marginally financed companies go bust and emotional investors panic in fear because of interest rate increases, bank failures, Enron, Lehman Brothers, Bird Flu, Swine Flu, Ebola, feel free to insert your crisis here and continue, but I think you can see where I'm going with this. The economy will temporarily sink below its average trendline. It's human nature and it will never change. However, because we are prudent investors we embrace it.
Market drops are common and predictable
Once per year the market will drop on average 10% and 1 in every 5 years or so it will drop at least 20%. A drop of 20% is what is known as a "bear" market. Since WWII there have been 14 bear markets which is one every 5.4 years. If you are in your twenties you will see 8 of them before you retire. If you are already retired you will see approximately 6 of them during your retirement. Nothing to be surprised or alarmed about. They are as common as dirt.
Let's now observe the percentage of rolling periods with positive returns for the S&P 500 from 1926 through 2021.
This means if you held an S&P 500 mutual fund for 1 year your chance of a positive return was 75%. If you held that fund for 5 years your chance of a positive return was 88%. And if we held it for 20 years our chance of a positive return is 100%. I like those odds.
Temporary market declines are not our enemy, nor is underperformance, or a recession or the deficit, or whatever the current crisis of the day is. Our enemy is our emotion and how we react to these temporary events. In the words of Harry Truman, "There is nothing new in the world except the history you do not know." This too shall pass.
You Need A Plan
A goal of retiring - without a plan - is simply a plan to run out of money. At 80/20 Financial Services we work to insure the money you need in the early years of retirement is safe and not subject to temporary market fluctuations, while at the same time putting the money you'll need in the later years of retirement in a position to receive the long term market returns necessary to provide an income that increases and outpaces inflation.
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We specialize in helping electric cooperative employees create their retirement income and investment plans. Retirement can last 20-30 years. You need a plan!
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