By Steve Doster | Mission Valley Money
The stock market dropped 10 percent during a two-week period at the end of January into early February. Hopefully you didn’t sell any investments and ignored all the hyped media coverage. It’s crucial to stick with your investments during market corrections.
We haven’t had a big correction in a long time. This one caught everyone by surprise because the economy is doing well. The recently passed tax law helped lower tax rates and was going to keep the economy moving along. There really was no reason for it other than people constantly saying the market can’t keep going up. And now there are tariffs being imposed and talks of a trade war.
You may have concerns when these corrections occur. It’s natural to feel this way. In fact, it’s built into our DNA as human beings. If a boulder comes tumbling down onto the road, it’s natural for us to think there are probably some more boulders on the way. Our bodies go on high alert looking out for the next boulder. This is called recency bias. We look at the very recent past to help us decide what might happen in the future.
Once on high alert, we start watching what others are doing. If one person starts to run, then a few more people start to run. You don’t know where they are running or if they see something you do not. The instinct to run is almost impossible to resist. Herd mentality takes over and you run with the herd to safety.
This is what happens during a stock market correction. The market just dropped 10 percent. Your survival instinct will scream at you, “It’s going to drop another 10 percent very soon! Everyone else is selling! Run for safety, too; sell everything now!”
Please don’t do this. Recency bias and herd mentality are a powerful combination. However, it is important to remember how well-functioning markets work. Markets adapt to changing expectations every minute. We expect the stock market to move up and down. Think of the alternative: If the stock market never moved and remained constant, we would be concerned that markets were not functioning properly.
There are a few keys to successful is investing:
Get your portfolio set up before a correction happens. A diversified portfolio of stocks, bonds, and real estate is your best protection against market corrections. Get the right mix of these investments that match your risk tolerance, age, and investment time horizon.
When a correction occurs, fight your instincts! Acknowledge your recency bias and then remind yourself that the long-term trend for a diversified portfolio is upward. The recent past is not a crystal ball for what’s going to happen in the future.
Remember that a drop in your portfolio is only paper loss. It only becomes a loss if you sell and lock it in. Your portfolio also continues to generate interest income and dividends during corrections.
Turn off the television and ignore what everyone else is doing during a correction. The average 20-something watches television about 25 hours per week. By the time you get into your 60s, that average doubles to 50 hours per week. Don’t set yourself up for failure by monitoring what everyone else is doing.
This seems like an easy task when your portfolio is doing well. It is much tougher when in the middle of a crisis. However, you can be successful by fighting your natural survival instincts and sticking with your investments during a correction.
—Steve Doster, CFP is the financial planning manager at Rowling & Associates – a fee-only wealth management firm in Mission Valley helping individuals create a worry-free financial life. They help people with taxes, investments, and retirement planning. Read more articles at rowling.com/blog.
