Morgan Housel, The Motley Fool
The funniest thing about markets is that all past crashes are viewed
as an opportunity, but all current and future crashes are viewed as a
risk.
CW8888:
For months, investors have been saying a pullback is
inevitable, healthy, and should be welcomed. Now, it's here, with the
Standard & Poor's 500 down about 10% from last month's highs.
Enter the maniacs.
"Carnage."
"Slaughter."
"Chaos."
Those are words I read in finance blogs this morning.
By
my count, this is the 90th 10% correction the market has experienced
since 1928. That's about once every 11 months, on average. It's been
three years since the last 10% correction, but you would think something
so normal wouldn't be so shocking.
But losing money hurts more than it should, and more than you think it will. In his book
Where Are the Customers' Yachts?, Fred Schwed wrote:
There
are certain things that cannot be adequately explained to a virgin
either by words or pictures. Not can any description I might offer here
ever approximate what it feels like to lose a chunk of money that you
used to own.
That's fair.
One lesson I learned after 2008 is that
it's much easier to say you'll be greedy when others are fearful than it
is to actually do it.
Regardless, this is a critical time to pay
attention as an investor. One of my favorite quotes is Napoleon's
definition of a military genius: "The man who can do the average thing
when all those around him are going crazy." It's the same in investing.
You don't have to be a genius to do well in investing. You just have to
not go crazy when everyone else is, like they are now.
Here are a few things to keep in mind to help you along.
Unless you're impatient, innumerate or an idiot, lower prices are your friend
You're
supposed to like market plunges because you can buy good companies at
lower prices. Before long, those prices rise and you'll be rewarded.
But you've heard that a thousand times.
There's a more compelling reason to like market plunges even if stocks never recover.
The
psuedoanonymous blogger Jesse Livermore asked a smart question this
year: Would you rather stocks soared 200%, or fell 66% and stayed there
forever? Literally, never recovering.
If you're a long-term investor, the second option is actually more lucrative.
That's
because so much of the market's long-term returns come from reinvesting
dividends. When share prices fall, dividend yields rise, and the
compounding effect of reinvesting dividends becomes more powerful. After
30 years, the plunge-and-no-recovery scenario beats out
boom-and-normal-growth market by a quarter of a percentage point per
year.
On that note, the S&P 500's dividend yield rose from 1.71% in September to 1.82% this week.
Whohoo!
Plunges are why stocks return more than other assets
Imagine if stocks weren't volatile. Imagine they went up 8% a year, every year, with no volatility.
Nice and stable.
What would happen in this world?
Nobody
would own bonds or cash, which return about zero percent. Why would you
if you could earn a steady, stable 8% return in stocks?
In this
world, stock prices would surge until they offered a return closer to
bonds and cash. If stocks really had no volatility, prices would rise
until they yielded the same amount as FDIC-insured savings accounts.
But
then -- priced for perfection with no room for error -- the first whiff
of real-world realities like disappointing earnings, rising interest
rates, recessions, terrorism, ebola, and political theater sends them
plunging.
So, if stocks never crashed, prices would rise so high
that a new crash was pretty much guaranteed. That's why the whole
history of the stock market is boom to bust, rinse, repeat. Volatility
is the price you have to be willing to pay to earn higher returns than
other assets.
They're not indicative of the crowd
It's easy
to watch the market fall 500 points and think, "Wow, everyone is
panicking. Everyone is selling. They know something I don't."
That's not true at all.
Market
prices reflect the last trade made. It shows the views of marginal
buyers and marginal sellers -- whoever was willing to buy at highest
price and sell at the lowest price. The most recent price can represent
one share traded, or 100,000 shares traded. Whatever it is, it doesn't
reflect the views of the vast majority of shareholders, who just sit
there doing nothing.
Consider: The S&P fell almost 20% in the
summer of 2011. That's a big fall. But at Vanguard -- one of the largest
money managers, with more than $3 trillion -- 98% of investors didn't
make a single change to their portfolios. "Ninety-eight percent took the
long-term view," wrote Vanguard's Steve Utkus. "Those trading are a
very small subset of investors."
A lot of what moves day-to-day prices are computers playing pat-a-cake with themselves. You shouldn't read into it for meaning.
They don't tell you anything about the economy
It's easy to look at plunging markets and think it's foretelling something bad in the economy, like a recession.
But that's not always the case.
As
my friend Ben Carlson showed yesterday, there have been 13 corrections
of 10% or more since World War II that were not followed by a recession.
Stocks fell 35% in 1987 with no subsequent recession.
There is a
huge disconnect between stocks and the economy. The correlation between
GDP growth and subsequent five-year market returns is -0.06 -- as in no
correlation whatsoever, basically.
Vanguard once showed that
rainfall -- yes, rainfall -- is a better predictor of future market
returns than trend GDP growth, earnings growth, interest rates, or
analyst forecasts. They all tell you effectively nothing about what
stocks might do next.
So, breathe. Go to the beach. Hang out with your friends. Stop checking your portfolio. Life will go on.
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