Young Investors Should Embrace, Not Fear, Market Corrections

Stock Market Decline 28_7_15.jpg

At the time of this writing, the stock market is in a slight rebound from Monday’s historic one-day decline and a 6 percent drawdown from its all-time highs last week.  Whether today’s “rally” signifies the bottom of a short market correction or a temporary upswing amidst a much larger fall is anyone’s guess.  Trying to make sense of short-term market swings is impossible and pointless.  Everyone wants an answer as to “why” Monday’s sell-off happened but the reality is that no one knows.  I don’t know.  You don’t know.  The guy on TV doesn’t know, nor does the financial writer for the Wall Street Journal or New York Times.  Trying to answer the next question, “how long will this last?” is just as futile. 

My simple answer as to why this is happening is that markets don’t JUST go up.  Over the past 8+ years, the stock market has experienced a strong run and the lack of recent drawdowns has given people a false sense of security that there’s little risk in investing.  This is particularly true for younger investors, many of whom have only experienced market gains in their short investing lives.  The irony of any panic among younger investors is that they should be excited by the occasional market drawdown, corrections (more than 10% declines) or full-blown bear markets (more than 20% declines). 

Most younger investors are net-savers.  This means they are saving more into the market than they are taking out.  Another way to say this is that they are BUYERS.  This is opposed to older demographics (primarily retirees) who are no longer contributing to their investment portfolios but rather drawing down on them.  These are the SELLERS because they need to liquidate their investments to fund their lifestyle.  While it is emotionally satisfying to see gains in an investment portfolio, all this means is that BUYERS are paying more for their current investments.  Paying more for a security today means less room for growth in the future.  For example, a salaried employee deferring 6% of their paycheck into their 401(k) every 2 weeks can now buy more this week than they could last week.  With long time horizons ahead of them (20+ years), the value of BUYERS’ investments accounts are almost certain to grow above their purchase price (assuming proper asset allocation and investor behavior).  Market corrections are nothing more than “stocks going on sale.” 

This type of market volatility is a good reminder of sound investment principles and practices:

  • Review your goals and your investment portfolio to understand any near-term cash flow needs.  In general, all short-term cash flow needs (spending, travel, car purchase, down payment for home, etc.) should be kept in cash or fixed income rather than equities.  This will protect the value of planned expenses from sharp falls right before the money needs to be used.
  • Use this as an opportunity to evaluate your asset allocation and appetite for risk, and rebalance accordingly.
  • Understand that markets do go up AND DOWN and accept volatility as the price of admission for long-term investment gain.
  • Don’t make investment decisions out of sudden emotion.  Sleep on it.  No plan must be changed due to the cause of one days’ market action.  Remember that over time, the stock market has delivered awesome returns for disciplined investors that patiently deploy a sound process. 
  • Never look to your friends, co-workers or the media for solutions to your investment concerns.  Everyone has their own plan, goals and timeline.  As such,investment decisions should be made with this full perspective in mind. 
  • Don’t try to time the market.  No one can consistently identify market drops and subsequent recoveries, so don’t even bother trying to figure it out.  Instead, stick to a long-term savings & investing process and focus your energy on more productive behavior.

Emotion and behavior play a much larger role in successful investing than stock market acumen or the ability to read financial charts.  Markets are unpredictable, rarely rational and don’t often make sense.  Understanding and accepting this unpredictive aspect of investing is the first step towards successfully navigating market volatility.