In our last special post we covered some of the economic issues we have been facing in the financial markets this past week, that have created a renewed volatility that is reviving those all too familiar unwelcome feelings among many investors—feelings of anxiety, fear, and a sense of utter powerlessness. While these are completely natural responses, today we want to address how acting on those emotions can end up doing us more harm than good.
While the S&P downgrade triggered much uncertainty in our financial state of affairs, we know these issues did not simply appear at that precise moment. It was the fact that attention was drawn to it that we began to experience these emotions, which in turn has created the violent ups and downs we have seen over the last week. It is all too reminiscent of the events of 2008, when the collapse of Lehman Brothers and the sub-prime mortgage crisis triggered a global market correction, and many investors did not want to ride that wave again so soon. At this moment, it is not good enough to have modest growth or profitable corporations. Instead we are looking to a government to “save us”; one that we are no longer sure can (if it ever could).
As to what happens next, no one knows for sure. That is part of long term and successful investing. But therein lays the key: investing is neither a short term proposition, nor is it something that can be taken on as an emotional task. The consequences can be too high. Remember how it felt in early 2009? What would have happened had we reacted emotionally instead of intellectually?! Here are a few points we want to call to your attention that can make living with this volatility more bearable:
- Markets are unpredictable and do not always react the way the experts predict they will. Remember what we called attention to on Tuesday. The recent downgrade by S&P of the US government’s credit rating actually led to a strengthening in Treasury bonds.
- Prices decline when more people are selling than buying. But don’t forget that every trade has two sides, and the buyers that step up see an opportunity. Those buyers are often the long-term investors.
- Market recoveries can come just as quickly and just as violently as the preceding correction. Again, recall in March 2009—when market sentiment was just as bad—the S&P 500 turned and put in seven consecutive months of gains totaling almost 80 percent! This is not a prediction, but just another reminder of how perseverance is critical to successful investing.
- Never forget the power of diversification. While equity markets have had a rocky time in 2011, fixed income markets have flourished, making the overall losses to balanced fund investors a little more bearable. Diversification spreads risk and can lessen the bumps in the road.
- As important as it is to remain modest when your portfolio is rising, it is equally important to temper your emotions in a downturn. As in life, moderation is a good policy.
The market volatility is scary indeed. What you are feeling is completely normal. Just remember though, by using solid discipline, meaningful diversification, and having a realistic understanding about how markets work, things have a tendency to work in your favor. Historically, market values will re-emerge, risk appetites will re-awaken, and for those of you who were able to acknowledge your emotions without acting on them, relief will replace anxiety.