Participating fully in corrections doesn't prevent long-term investors from reaching their goals. Over time, corrections—quick drops of around -10% or worse—become blips. As long as you are invested during bull markets, getting the big returns on either side of corrections, the pullbacks become an afterthought. Consider the 1990s, history's longest bull market. Which do you remember more: world stocks' four corrections, or their 268.4% total return?[i] Selling out near a correction's bottom, however, can have lasting effects. The combination of locked-in losses and missed upside can set you back, giving you an extra hurdle to clear. Opportunity cost is money lost.
Our advice might be hard to internalize and act on if we get another downswing. Human nature makes investors want to stop the bleeding, and a media freak-out could compound that. The good news is there are some practical steps you can take to reduce or avoid temptation to make a hasty move.
We certainly enjoy a taste of CNBC, Fox Business, Bloomberg TV and all the rest from time to time, but we've found tuning into channels that cover financial markets as if they're an all-day sporting event can do more harm than good during a correction. Television channels are in the ratings game, and the way to get ratings is to whip up a frenzy—for markets, that can mean overthinking, overdramatizing and exaggerating. If you can distance yourself, it's all very entertaining at times. But for most folks, watching the spectacle can stir up emotions, and emotions are your enemy.
An occasional check-in is fine, but the more you log in, the more you open yourself up for error.[ii] Seeing a graphic about the market's performance on the nightly news is one thing. Seeing the impact of that movement on your own portfolio is another, and for many folks, it can trigger a "fight or flight" response. Neither is terribly healthy. Flight-cashing out-can put your portfolio on the sidelines when the good times resume. Fight—piling into something designed to profit from a decline, like a short position—could expose your portfolio to further declines once stocks start rebounding. The less you set yourself up to have a "I have to do something" moment, the better off you'll likely be in the long run. It might not feel like it today, tomorrow or the next day, but in the long run, you'll thank yourself.
In investing, your biggest enemy is probably yourself-your emotions and all the impulses they trigger, in good times and bad. We are hard-wired to want to erase any trace of negativity from our portfolio. Prospect theory, also known as myopic loss aversion, holds that we hate losses over twice as much as we love gains, and it triggers a desire to make red ink disappear. If you sell, at least you don't have to watch your account fall any more. (Never mind that, as we discussed above, this also turns a temporary decline into an actual loss.) This and other behavioral errors—which all boil down to acting on fear and greed—cause folks to sell low and buy high, which can make your long-term goals significantly harder to reach.
Little things can help, too. Engaging in life's simple pleasures can help take your mind off the stock market and renew your perspective. A brisk walk (depending on your climate) is a marvelous way to clear your head and get some endorphins. We're also fans of spending time with family and friends, playing with pets, reading a good book, watching an old movie, catching up on a TV show, crafting, building, cleaning, gardening and cooking. All can distract from the temptation to just do something about whatever the market does on any given day.
No one can know when stocks will turn up. Whenever the rebound arrives, it will likely be clear only in hindsight. We also think there is plenty more upside left in this bull market, and we want all our readers to be able to enjoy its fruits. So stay cool, hang on and try to relax. It might be hard at times, but we believe you'll find it's worth the effort over time.
[i] FactSet, as of 9/28/2015. MSCI World Index returns with net dividends, 9/28/1990 - 3/24/2000.
[ii] This is true when markets are on an upswing, too. Overconfidence and pride accumulation-manifestations of greed-are every bit as dangerous as correction-related behavioral errors.