There is no question that the market has changed its character recently and while its impossible to predict the future, the past two days the market has come down fairly hard. There is lots of hand wringing in the media and there are all sorts of explanations: China, Currency Wars, overvaluation, rising interest rates, Greece, etc. etc. etc. If you listen to the pundits, you should get out now. Just sell everything. I am sure that clients are calling their financial advisors in a panic and often, the client has been panicking enough before the call that the advisor cannot talk them off the cliff. Sell it all and put it in cash. It doesn't matter what the investments actually were. It doesn't matter what the tax consequences (you have to pay capital gains tax if you had a gain). Just sell. Sell it all!!!!!!
In this blog posting I am going to talk you off the cliff, although hopefully you aren't actually on the cliff. I'm going to talk to you about how the market really works so you can relax and enjoy the benefits of losing money (seriously!).
First of all, I'd like to introduce you to Mr. Market. He is a gentleman who is perfectly pleasant some of the time, but he has been hiding an unfortunate mental health problem from you. Mr. Market is actually a manic-depressive. He seems normal a lot of the time, but sometimes he is wildly enthusiastic and carries you along with his enthusiasm. And just when his enthusiasm starts carrying you along, Mr. Market goes into a deep funk and becomes so depressed he convinces you that the world is coming to an end and the only thing to do is repair to your pre-prepared bomb shelter. Of course you don't have a bomb shelter so you start making one. As soon as you finish, Mr. Market will come back and ask you what you're doing and tell you everything is fine and there's nothing to worry about. After this cycle, you will definitely decide you've hung out with Mr. Market enough. Oh and Mr. Market has some buddies that just shout out whatever Mr. Market is saying so loudly you can't think. Mr. Market's buddies are the financial news media.
My point with this analogy (and apologies to Benjamin Graham who first came up with the Mr. Market analogy) is that you shouldn't be making your investment decisions based on the rantings of a manic-depressive. You have an investment plan which should be based on your timeframe, your ability to withstand short-term losses, and your innate risk-tolerance. The actual investments in your portfolio should be broadly diversified to reduce non-systemic-risk. In other words, if a particular company (think Apple), sector (think Chinese stocks), or locale (think Detroit) implodes, the impact on your overall portfolio will be muted.
Your portfolio IS going to go down during these episodes. No question about it. Do you need this money today? The answer had better be no or you shouldn't be in the market. If you have a broadly diversified portfolio, chances are the downturn of your portfolio will be less than the overall market AND will last a relatively short amount of time. How short? In a typically correction, you will make it all back and more in 6 months. In a bear market, it might take a little longer, but typically within a year or two.
But, you say, I know the market is going down and everyone says it will be a 20% plus correction or a bear market and I need to sell now to avoid the market going down and preserve my capital. YOU are trying to time the market. You think you can predict when the market is going down, how far it will go down, and when it will go back up. Let me tell you, you are WRONG! In fact, there are no accurate ways to predict these things and the most important thing which is almost never predicted properly is when the market starts to rise again. And this is really important because your biggest gains are actually going to be when the market just starts to go up again and you are going to miss it. Also, you are likely going to decide to sell just at the point where the market has pretty-much stopped going down because that's when the pundits are shouting "bear market". So what you wind up doing is selling near the bottom and buying again after the best gains have already been made. Is this how you make the most money? I think you know the answer.
And by the way, what often happens during market downturns is that sectors which have not performed well become the next upturn leaders. Sectors which have done well previously stay down. So, I am not advocating doing nothing during the downturn. Whoever is managing your money should be continuously examining the investment thesis of each investment and buy or sell based on this investment thesis. So trading during the downturn might be the right thing to do, but its not done in a panic, but with a plan in mind. And staying in the overall market.
The market needs corrections. Corrections allow for the sector rotation which I described previously. It allows valuations which have become stretched to come down and allows undervalued investments to rise. Many people think the current market is long overdue for a correction and this may be one now. But it doesn't mean you going to stop making money, only that there might be a slight pause and some short-term pain.
So what should you do? You should stick with your long-term plan. If your goals and personal situation have not changed, then Mr. Market's gyrations should not affect you. Don't even pay attention to them. Or view them with some amusement. Pretend you are a close relative of Mr. Market. You understand his mental illness, love him anyway, but try not to be too influenced by him.
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