Crashes are a fact of life.
The housing market and the stock market are both prone to crashes. It’s just that these crashes look different.
In a housing market crash, prices are “sticky” and slow to adjust downwards as sellers resist price cuts. Transactions dry up, people stay put and it can take years for prices to adjust fully and the market to function normally again.
Much of the adjustment happens via inflation. In other words, house prices flatline for several years whilst inflation cuts those prices in real terms. The last proper UK housing crash was in 1990 and it took over 5 years for the market to clear and normalise.
The stockmarket “clears” more quickly. It’s a faster, more efficient market than the housing market. There’s an old stock market saying that the stockmarket climbs up the stairs and goes down the escalator.
In other words, prices adjust downward quickly and could easily fall by say 30% in a week (e.g. October 1987) to restore the balance between buyers and sellers. The process is much shorter and sharper and therefore much more visible in the stock market vs the housing market.
The media know that crashes scare people and keeps them hooked on their news product. So stock market crashes get a load of attention. Another reason why no news is good news.
It’s easy to invest effectively as long as you never panic sell during market crashes. There is no more important message than this in investing.
So today, I’m featuring an extract from JL Collins excellent book The Simple Path to Wealth to remind us that we need to toughen up to be good investors.
So how should we deal with the coming stockmarket crash if we are invested in shares? Here’s JL Collins:
Pundits and professors say “treat the symptoms” of volatility.
They default to broad asset allocation. They would have us invest in everything and hope a couple of those puppies pull through.
To do this properly would require a ton of work. You would need to understand all the various asset classes, decide what percentage to hold of each and choose how to own them. Once you did that you’d need to track them rebalancing as necessary.
The result of all this effort is to guarantee sub-par performance over time while offering the slim hope of increased security. I am reminded of the quote: “Those who would trade liberty for security deserve neither“.
Toughen up cupcake…
…and cure your bad behaviour.
This means you must recognise the counterproductive pyschology that causes bad investment decisions – such as panic selling – and correct it in yourself. In doing so, your investments will be far simpler and your results far stronger.
To start you need to understand a few things about the stock market:
1. Market crashes are to be expected
What happened in 2008 was not something unheard off. It has happened before and it will happen again. And again. In the 40 odd years I’ve been investing we’ve had:
- the great recession of 1974-75
- the massive inflation of the early 1980s when mortgage rates were pushing 20%
- the crash of 1987 (~30% fall in a week)
- the tech crash of 2000-03
2. The market always recovers
Always. And, if someday it doesn’t, no investment will be safe and none of this financial stuff will matter anyway. In 1974 the Dow closed at 616. At the end of 2014 it was 17,823. An impressive result through all the disasters.
All you would have had to do was toughen up and let it ride. Take a moment and let that sink in.
Everybody makes money when the market is rising. But what determines whether it will make you wealthy or leave you bleeding on the side of the road is what you do during the times it is collapsing.
3. The market always goes up
Understand that this is not to say it is a smooth ride.
It’s not. It is most often a wild and rocky road.
But it always goes up. Not every year. Not every month. not every week and certainly not every day.
But take a look at a chart of the US stock market 1900 – 2012. The trend is relentlessly, through disaster after disaster, up.
4. The stock market is the best performing investment class over time
5. The future will have as many collapses, recessions and disasters as the past
Its not possible to prevent them. Every time this happens your investments will take a hit. Every time it will be as scary as hell. Every time all the smart guys will be screaming: Sell!! And every time only those few with enough nerve will stay the course and prosper.
This is why you have to toughen up, learn to ignore the noise and ride out the storm; adding still more money to your investments as you go.
To be strong enough to stay the course you need to know these bad things are coming – not only intellectually but on an emotional level as well. You need to know this deep in your gut. They will happen. They will hurt. But like blizzards in winter they should never be a surprise [TEA: South West Trains please take note]. And unless you panic, they won’t matter.
There’s a major market crash coming!! And there’ll be another after that!! What wonderful buying opportunities they’ll be.
I tell my 24 year old that during her 60-70 odd years of being an investor, she can expect to see 2008 level financial meltdowns every 25 years or so. That’s 2 – 3 of these economic “end of the world” events coming her (and your) way. Smaller collapses will occur even more often.
The thing is, they are never the end of the world. They are part of the process. So is all the panic that surrounds them. Don’t worry. The world isn’t going to end on our watch. It is hubris to think it will.
Of course, over those same years she’s going to see several major bull markets as well. Some will rage beyond all reason, along with the hype that will surround them. When those occur, the financial media will declare “this time it’s different” with all the same confidence as when they claimed the end had come. In this too they will be wrong.
But yer gonna have to be tough.
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