You wake up next Monday, turn on the television, and the news anchors look grim. The Hang Seng has just had a disastrous day, closing down 25%. In pre-market trading, indications are that the New York Stock Exchange will have a delayed opening. In other words, a rough way to start the week.
What’s going through your head? Do you hear…
Negative Thoughts (that may induce panic and poor decision-making):
- I knew the market was overvalued; I should have sold out last week.
- I’ve got to stop my monthly investment contributions to conserve cash flow.
- Why in the world did I agree to that big mortgage? I need my annual bonus just to cover the property tax. Now what?
- Am I going to have to push back retirement?
- This is a game-changer. The stock market will be dead money for years.
Positive Thoughts (that support and encourage a rational response):
- Hey, I’ve been through this before. We’ll get through it.
- I have almost 5 years’ worth of living expenses in cash and short-term bonds. Recessions generally last less than 2.5 years. There’s no need to sell stocks to maintain my standard of living.
- That 2% interest rate on my bonds is looking pretty good right now.
- Glad I paid cash for the car last year—would hate to be making that payment right now.
- Let’s keep making monthly contributions to the 401k and brokerage account. It’s good to buy stocks “on sale”.
- I embrace volatility because I don’t need to sell any stocks today and I know that risk is what allows me to earn high returns over time.
Ok, let’s be real. Even if we have planned ahead, there may be a few choice words that escape our lips before we can hear those positive thoughts, but you get the picture. It’s all about being prepared and having the right attitude. Discipline is key and having the right advisor (one who will hold you accountable) during both the good times and the bad can mean the difference between staying on track and meeting your long-term goals, or being the victim of a future “lost decade”.
The next recession is always around the corner. The only questions are “When?” and “How bad?” Losing money on paper from time to time is a given for those who take the risk to invest. What’s most important is how you react during crisis. Successful investors (like Warren Buffett) are able to embrace volatility because they understand that short-term paper losses are just part of the game.
We believe that investors need the following to successfully embrace volatility:
- Strong stomach (experience and having a solid plan helps in this area)
- Healthy emergency fund (six months of basic living expenses in “cash”)
- Low fixed expenses relative to income (keep fixed expenses less than 50% of income)
- Proper asset allocation (the right mix of stocks and bonds for your unique situation)
No matter how high your risk tolerance, a strong stomach won’t save you from selling out of the market if you don’t have sufficient cash to meet your obligations. One of the worst feelings in the world is to get laid off with a mountain of debt and bills staring you in the face. When times are good, it’s easy to become less fiscally responsible (e.g., “Let’s put this on the card, and we’ll pay it off with my next bonus”). Don’t be that person. Take advantage of the good times to shore up your emergency fund and get your financial house lean and mean. That way, when faced with the next economic speed bump, you’ll be able to sleep better at night knowing that the positives in your financial life outweigh the negatives.