When, and how, will it end?
With the stock market making all-time new highs on a regular basis, this is the question I’m most asked by friends.
Indeed, most investors both simultaneously love and hate bull markets. They love to see their portfolios swelling due to price increases, but as they swell, those same investors also worry about what could happen next – a correction…or worse a recession… that could harm their portfolio’s value.
Let me state early-on in this essay – I don’t have a clue as to when or how the current bull market will end. I hope you appreciate that honesty and transparency. In fact, I always get a laugh when the talking heads on TV start making predictions about the stock market’s direction. How could they know for certain? As the old joke goes, “Economists have predicted 11 out of the last 2 recessions.” LOL.
I will tell you what I know about bull markets, so that you, an intelligent investor (you are investing intelligently right?) can form your own opinions. After all, that’s what intelligent investing is all about – doing your homework, researching, and constantly learning. It’s your money. You should have an active role in managing it.
Here’s what I know…
Investors get specifically nervous by big returns in the market. It seems like too much. But bull markets don’t die of old age. Nor do they die from producing above-average returns.
Quite the contrary…
You see, we tend to think in terms of averages for the market. Indeed, the nightly news reports the condition of today’s market relative to the “big average”, the Dow Jones Industrial Average. Also, stock market statistics are generally reported as compared to some historical average. So, we think in averages.
That’s all fine, but that can lead us to think that anything above average is abnormal, and thus something we should fear. When the opposite is true.
A common refrain that you’ll hear is that the historical returns for the market average about 10%. That’s true. But while it’s true, it doesn’t paint the entire picture, especially related to bull markets. The fact is, stocks typically don’t rise an average of 10% in bull markets, they have risen an average of 21.2% annually. Here’s another statistic: Bear markets average about 21 months in duration. And bull markets? They average 57 months! It may be hard to believe, but bull markets are longer and stronger than people remember and they are above average by nature.
So, why don’t people remember these facts?
Because of human nature.
Our ancestors were rewarded for reacting to fear, not for being analytical or discerning. When the sabre tooth tiger decides it wants you for lunch, what pays is running, not research!
Psychologists also have confirmed many times, through countless studies, that we experience pain much more acutely than pleasure, by a ratio of at least 2 to 1. Yes, that means that we feel the pain of losing a dollar much more than the pleasure of gaining that same dollar.
So, put together, this means that humans are naturally afraid of heights. When the market rises significantly after a scary bear market (remember the 2008 recession?), they fear the market will revert back. And since we hate losses more than we like gains, that fear of heights is double scary.
What does this mean to the average investor?
If we let our emotions drive our investing decisions, we’re likely to make mistakes. Our investing decisions should be made based on calm, sound reasoning.
The optimum response to emotion in investing is to acknowledge it without, if possible, allowing it to cause an investor to deviate from the financial plan that has been created to help advance the investor’s goals. Discipline is the key to successful investing. Here’s Buffett:
‘Success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing.’
Letting emotions drive investment decisions is one of the most common investing mistakes. Consider the returns of 401(k) account holders who pulled money out of the market and sat on the sidelines during the financial crisis. From September 2008 to March 2010, they lost an average of nearly 7% in their accounts, according to a Fidelity study of more than 11 million 401(k) accounts.
Investors who rode the downturn, maintained their stock allocation and continued to make regular contributions to their retirement account during the same time frame saw their 401(k) balances increase roughly 22%. Proof, as Buffett says, that temperament — is a powerful investing tool.
For hundreds of thousands of years, a human being’s survival depended on his or her ability to analyze a situation based on limited information and then make quick emotion-based decisions such as fighting, hiding or running away. What was a great trait for surviving and thriving in the jungle doesn’t work so well in the stock market.
What does work well?
Following your plan.
Discipline can be the antidote to the emotions that drive your investing astray. Following a well-designed investment plan will keep you on track to achieve long-term financial goals.
Some pointers on avoiding the emotional tug of war in investing:
Have a specific plan. Most investors follow a strategy in their head that is highly changeable. A more structured plan — spelling out long-term goals, approaches to risk and return, and strategies to achieve those goals — will serve as a steady guide.
Track progress on a schedule. Obsessing over investments daily or moment to moment is counterproductive because of the temptation to make frequent changes. Reviewing your portfolio regularly but not too frequently will help separate you emotionally from the swings of the market.
Learn how to sit still. Be aware that volatile markets make it hard to do nothing. If the stock market drops today, the temptation is to sell stocks, buy, or react in some way. But responding to every market fluctuation is focusing on the small picture. Practice the habit of focusing on the larger picture, which includes your financial goals and long-term strategies.
Give yourself a checkup on the common emotions that lead to investing mistakes.
Put your energy into designing and following a sound long-term investment plan. A plan that will take you to financial freedom.
Be free. Nothing else is worth it.
P.S. Why aren’t you wealthy yet? It’s because of something you don’t know. Otherwise you’d already be rich! Isn’t it time to learn what you don’t know? Consider signing-up for my newsletter below, to help you build wealth faster.
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