One of the greatest actions you can take to educate yourself about markets and economies…
If you automatically calculate how much money you “lose” when the stock market goes down, then you may require a psychological reset if you plan to remain invested in the market.
Let’s assume that you bought a house for $300,000 on January 15. On July 1, a man who you’ve never met before approaches you while you’re in your front yard and asks to buy your house for $275,000. You likely would tell this person that you have no interest in selling your home. The potential buyer then leaves, and life goes on.
In this scenario, nobody would think that you lost $25,000 on account of the potential buyer’s low asking price. This is because you had no intention of selling your home, and you realize that your new home is likely to be worth more over time. If 10 years later you sell your house and net only $275,000, then you would clearly assess that you lost $25,000.
If this thought process rings true with buying and selling real estate, then why is it so difficult to translate this same mentality to stock and bond investing? The answer is that there is a daily quote generated for those investments that you purchased yesterday. If this quote rises higher, then you feel financially savvy; if it drops lower, then you feel as if you have been duped.
If a stock investor invests $100,000 in the market in the year 2000, and this amount grows to $500,000 by September 2018 but then drops to $450,000, this will be thought of as a $50,000 loss. Why is it not instead thought of as a $350,000 gain? Not to think as much is representative of the dysfunctional psychology of subpar investors, because the markets are volatile on a day-to-day basis. Daily markets are nothing more than a voting machine of popularity. A wise investor is aware of this and is quite content with purchasing strong assets over extended periods of time for a likely gain. When buying or selling shares, they do not worry about whether they have hit the top or bottom of the daily price swings. An old, but brilliant Wall Street adage is, “Bulls make money, bears make money, pigs get slaughtered.” In essence, if you are investing solely to make maximum amounts of money, then your greed will ultimately take you down.
The Ebb & Flow of the Stock Market
Markets go up and down. When markets go down, it is normally a more dramatic scene then that of the slow-and-steady rising markets. This is true for a few reasons. One reason can be attributed to computer algorithms, which attempt to move market momentum in a negative direction in the hopes that fearful investors will push markets even lower, thus fulfilling their bets on a down market. Another reason can be linked to manipulative investors who try to push the market lower to encourage fearful investors to sell so manipulative investors can buy up stocks at the low price, driving prices down even further. Causing fear and panic is a very profitable game. The key is not to play the game by understanding what you own and why you own it.
Some of the best types of investments to own are index funds and actively managed mutual funds. These are diversified funds of the greatest companies in not only America, but also around the world. Will the value of these funds drop and stay down forever? Despite everything that the market has weathered in the past (depressions, recessions, inflation, war, etc.), the answer is most likely no. If, however, all of your money was invested in one specific stock—no matter how financially strong or stable the company—then the answer could be yes, depending on the cause of low earnings within said company (e.g., General Electric [GE], whose stock value went up for 100 years but now is suffering continued great losses). Many indexes and mutual funds may have had a portion of GE in their overall portfolio, but when GE stock values began to continually fall, this portion of the portfolio could be weeded out (sold) without causing a significant negative impact on the financial integrity of the account.
The best way to lose money is to react to worry and fear by selling your stocks at a price lower than what you paid for them. Once you sell at a lower price than what you paid for the stock, then you do indeed lose. At the Financial Consulate, we usually have non-stock assets available to sell in case our clients need a monthly draw or random cash withdraw. This protects our clients from having to sell stock funds during a market downturn.
The markets can be rather simple and complex at the same time. They are simple if you can wrap your mind around how they operate but are complex if you try to predict their daily fluctuations. For example, in 2007, Apple was planning to release the iPhone and iPad, yet by mid-2009, the stock had declined by 50%. The stock then went up almost 10-fold, which is representative of the great company that we know today. Apple’s stock dropped during those years because people grew afraid that the stock wouldn’t perform and thus wanted out, but the smart investors were educated in their ownership of Apple stock, did not sell, and were rewarded well in the process.
At the Financial Consulate, one of our jobs is to educate our clients about the nature of the investments that they own so that they need not worry about the ups and downs of the markets. Your best defense from selling stocks prematurely on the basis of greed or fear is to not watch the daily actions of the markets, but instead to understand the stocks that you own and your plan.