Two “Don’ts” and One “Do” for Market Volatility

Volatility continued Monday, and if you watched the market leaderboard, it was probably hard not to feel antsy. World stocks hit a new year-to-date low, breaching August 25's low-water mark, and the S&P 500 is inches away. We'd say this is now officially a double-bottom correction, but that implies the second bottom has happened for sure. Unfortunately, it is way too soon to know whether that's the case-short-term volatility is impossible to predict, and more downside could lurk. But whether or not the bottom comes today, next month or next year, we still believe the right move is to hang on, keep your eye on your long-term goals, and ignore the temptation to do something hasty.

Through Monday's close, world stocks are down -13.9% since May 21.^[i] The S&P 500 is down -11.7%.^[ii] If you have hung on so far, this probably feels like a loss, but it isn't. It is a decline. A decline becomes a loss-as in an actual, realized loss-only if you sell. If you stay in, when the decline reverses, you get to participate in the rebound and make up lost ground, something stocks usually do quickly after corrections. If you sell, chances are you sit out some or all of that rebound, depending on when and if you get back in.

Participating fully in corrections doesn't prevent long-term investors from reaching their goals. Over time, even severe corrections-those sharp, 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?^[iii] Selling out near a correction's bottom, however, can have lasting effects. The combination of locked-in losses and missed upside 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. So far, headlines have been relatively calm during this correction. As we perused the headlines mid-day Monday, few focused on markets, and none that we could find noted world stocks' heading toward new lows. This is rather odd this deep into a correction, and the rebound might not start until we get a broad capitulation. (Or it might turn without a broad freak-out-day-to-day sentiment, like short-term volatility, is unpredictable.) If the media's relative calm vanishes, temptation to sell could get far more powerful.

The good news is there are some practical steps you can take to reduce or avoid temptation to make a hasty move.

Don't watch financial/business television. 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.

Don't log into your online brokerage account every day. An occasional check-in is fine, but the more you log in, the more you open yourself up for error.^[iv] 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-puts you on the sidelines when the good times resume. Fight-piling into something designed to profit from a decline, like a short position-could expose you 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.

Know your enemy. 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. Hence, at times like this, we encourage investors to seek out words of wisdom and read some behavioral finance basics. At the risk of shameless self-promotion, our boss, Ken Fisher, has a great primer in Chapter 3 of his 2006 book, The Only Three Questions That Count. Legendary investor Ben Graham has many goodies in his classic, The Intelligent Investor, particularly in Chapter 8, where he discusses the whims of "Mr. Market." We're also big fans of Fred Schwed's Where Are the Customers' Yachts?, which (though antiquated) shows the folly of trying to predict, time or explain short-term swings.

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 autumn walk (or Indian summer stroll, 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 be clear only in hindsight. But with market fundamentals still broadly positive, we do have every reason to believe more downside lies behind us than ahead of us. 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.