"Widespread fear is your friend as an investor because it serves up bargain purchases." - Warren Buffett
For millions around the world, the pandemic has served as a source of financial distress and worry. This is particularly true for investors. Stock market volatility is the highest it’s been since Black Monday, over 30 years ago - not to mention the fact that this is the largest volatility spike linked to a disease outbreak in history.1 But don't let these "scary markets" get to you. How you react to them will have a lasting, and potentially damaging impact on your financial goals - like retirement or leaving a legacy to your children.
Back in April, I wrote a blog post about something known as the Behavior Gap. The Behavior Gap refers to the difference between a smart financial decision versus what investors actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap — “the behavior gap” — between their lower returns and what they could have earned. Investors often make poor financial decisions when experiencing panic or anxiety as a result of personal or widespread events. The pandemic is one such event that has had this effect on people.
Living through COVID-19 is stressful enough. Feeling hopeless about an unpredictable stock market certainly isn’t any help. If you’re one of many worrying about their investments, these are some dependable ways to reduce stress and make a plan moving forward.
Prioritizing Your Mental Health
Psychological professionals have long acknowledged the detrimental effects of stress. It impacts sleep, cognition, and overall physical health.2 In times of financial as well as social uncertainty, it’s important to first regulate your mental well-being; high stress levels actually change human perception, increasing the likelihood of impulsive decision-making.3 Due to this, it’s wise to consider certain stress-managing lifestyle changes before making any big investment-related decisions.
Reducing Stress Without Changing Your Finances
Stress makes us feel as if we are losing control. This is why it’s vital to take control of your lifestyle, independent of finances, wherever you can. The following suggestions have been proven to have positive effects:4
- Focus on wellness. They are timeworn suggestions, but they work: exercise regularly, get enough sleep, eat well, and practice mindfulness. Allocate time to engage in recreational activities that make you happy, or explore a new hobby.
- Don’t use unhealthy coping mechanisms. These can be harder to recognize than one might expect. Don’t smoke or drink in excess to cope with stress, but also be wary of overworking yourself or unnecessary risk-taking.
- Stay socially connected. Social support increases resilience to stress.5 Experiencing the combined effects of financial stress and social distancing measures from coronavirus makes people susceptible to feelings of isolation. Lean into your support system and connect with others to avoid feeling consumed by anxious thoughts.
Approaching the Volatile Market
While all of the aforementioned actions can help you handle stress, it’s impossible to truly do so without addressing the stressor: the worry you have about your investments.
The first step is to accept what’s happening economically. The optimistic bull run of the past 11 years took a swift downturn, and we’re now in a period of inconsistency.6 That doesn’t mean investors have to live in a constant state of stock-induced anxiety, although it can be difficult not to. In how you approach the stock market, keep these guidelines in mind.
A Little Perspective
The following chart from Dimensional Fund Advisors is one of my favorites. It simply puts over 90 years of stock market returns into a simple to understand chart. At a quick glance, the first thing that we notice is that there are far more positive years (69) than negative ones (25). That's a pretty good win percentage. This perspective alone should help an investor cope with their feelings surrounding a decline in the stock market.
Another interesting tidbit displayed above is that while the stock market has averaged a gain of about 10% annually, only six years out of 94 had returns that came within two percentage points of 10%! Yearly returns have been as high as 54% and as low as -43%. That is a large range of potential returns. But in any given year, you should not be surprised to see returns within that range.
Take a Break
Over-checking your portfolio is ill-advised in general and even more so during market downturns. For most, investing is a long-term proposition. Constantly checking your investments is not only unnecessary but often a source of aggravated stress - the same goes for over-consuming news about the stock market. This can increase the chance of making hasty, emotionally-driven decisions. It may be in your best interest to momentarily step away from your investments in order to gain perspective.
Assess Your Investing Goals
While you should avoid over-checking it, seasons of volatility are a great time to reassess your portfolio and remind yourself of your long-term goals. Why is your portfolio made up of these specific investments? Why are you investing in the first place?
Despite a dynamic stock market, it’s probable that investors’ long-term goals remain unchanged. Keeping yourself conscious of these long-term returns is crucial; remember that your investment plans will outlast a period of market volatility.
Making Investment Decisions
A large proportion of stock market investors possess a trait that is extremely detrimental to them achieving investment success. It is a puzzling piece of human nature that we only seem to see exhibited with regard to the stock market. It's not their fault - it just appears to be the way most people are "wired".
Let me explain. In almost every facet of our economic lives, we actively seek out bargains. If something is on sale, we stock up on it. The thrill of getting a bargain draws us in. How else do you explain Black Friday and end of the year car sales at your local automobile dealership? At the same time, we tend to shun things that are getting more expensive. We look for substitutes like generic or store brands. This is perfectly normal behavior.
Now a funny thing happens when it comes to the stock market. This totally rational and normal behavior suddenly gets tossed out the window. When the price of stocks drop, investors panic and succumb to fear. They feel the inexorable need to sell their stocks before the loss that they are experiencing (albeit temporarily) gets worse. This is a very powerful and instinctive human impulse. But if acted upon, it is also an extremely serious mistake. One that can have a long-term detrimental impact on retirement plans and overall financial security.
Even though history (see the chart above) has shown that the stock market declines are temporary and the gains are permanent, people still make the mistake of selling when the stock market is declining. In every instance before, the stock market declines have been overcome and successful investors who held on through it all have been rewarded.
Seek the Help of a Financial Advisor
If you have an advisor, talk to them about your concerns. If you don’t have an advisor and think that it is time to work with one, now’s an opportune time. No matter your circumstances, the fundamental piece of advice is to avoid making an uninformed decision. Patiently observing your losses isn’t easy - but note that as bear markets average losses of 33%, bull markets are much longer in duration and come with average gains of 159%.7
Remember that, historically, the stock market has recovered.8 Bear markets are a normal part of investing. It’s hard to see an upside as anxiety spreads among investors. It’s understandably stressful when you feel the security of your investments is threatened - but don’t allow a volatile market to cause you too much distress. Long-term returns will outweigh the short-term losses. Until then, focus on your mental well-being and solidify your financial plans. Trust me when I say, "Your future self will thank you!".
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.