Day-to-day changes in the stock market (i.e. volatility) are stressful to most people
With the right mentality and investment approach you can be calm and confident
Here’s why and how…
It feels like the stock market is in a perpetual state of enormous flux. Everyday the stock market, Dow Jones and S&P go up and down on headlines of “Global Trade Wars” and “Inverted Yield Curves.”
This scares people for two reasons:
(1) Uncertainty and confusion from these scary headlines. People don’t like things they don’t understand. Few can explain what either of those headlines really means, and
(2) Change. Humans loathe change, and change is what’s happening daily in the stock market. Stock market volatility is a measure of how much prices are changing. And most people hate change and so they hate volatility. We prefer “steady as she goes…”
First let’s keep things in perspective. It’s actually been a fantastic year for US financial markets. Trade wars and Trump tweeting notwithstanding, thru Friday Sept 13, the stock market is up 20% and Bonds are up 7%, year-to-date. Those are great numbers; healthy robust returns.
Hopefully, you didn’t panic and get out of the market too early.
How to calm down and enjoy the ride?
It’s actually quite simple in 3 steps: Diversify, Rebalance, Plan and enjoy long steady returns.
Diversification
The importance of diversification can not be overstated. Not only is it supported by Modern Portfolio Theory, Ray Dalio (good article here), and most every financial advisor, but possibly more impactful is the psychological well-being it delivers. If stocks are down 10%, there is nothing more satisfying than seeing your bond portfolio up 10%, even if bonds are only 30% of your portfolio. It feels like a big win. In fact, you feel like you out-smarted the market.
Below is a graphic that you can find all over the internet in various shapes and sizes (and asset class slices), the point of which is to show that every year the relative performance of asset classes moves around. The diversified portfolio virtually guarantees you healthy returns in the long run. It is less jumpy and volatile and is represented by the black line and boxes below.
Rebalance
Rebalancing is a classic investment discipline, a mechanism for buy low sell high, and it will keep you honest and safe in the long-run. Rebalancing is the concept of keeping your portfolio in line with your goals and risk tolerance. So if your optimal balance is 70% stocks and 30% bonds (which by the way is generally a good mix for income generating middle-agers), then you should periodically “rebalance” your portfolio to ensure this allocation maintains.
Being Diversified and Rebalancing creates win/win scenarios psychologically. This is key for reducing stress and staying positive.
The stock market and bond markets usually move inversely. So when stocks go down, bonds go up. This is because when investors are selling stocks they are reallocating money to safer assets, like bonds (this is also referred to as “flight to safety”). Supply and demand at work.
Here is how the win/win scenarios play out:
I acknowledge that you may not consider it a “win” when 70% of your stock portfolio is down, but consider the following… Between January 2000 and December 2009 the US stock market returned a cumulative -5% (i.e. negative return). This is referred to as the lost decade in the United States, but it was not lost for those with diversified portfolios.
A diversified portfolio of 70/30 stocks and bonds would have returned 20% over that time period.
The Plan
You need to be committed to your diversification and rebalancing strategy. It should be on “auto-pilot”.
(1) This helps psychologically, because you shouldn’t be burning energy in decision making.
(2) It helps financially, because in addition to the benefits listed above, it ensures you that you stick with a certain investment or asset class even when it is low so that you ride it high again. Remember every asset class will rebound, but far too often investors panic and sell low.
You need a written financial plan. If you are over the age of 30 you should have a documented financial plan in place, and you should revisit it at least annually. In the workplace you set SMART goals. Likewise, to achieve results in your personal life, you also need to set goals and measure progress.
There are many excuses for not having a financial plan:
– I don’t make enough money to save anything.
– I make so much money I’m not worried about retirement.
– I’m maxing-out my 401k, things are probably fine.
This analogy will not resonate with everyone, but putting a financial plan in place, is like getting a comprehensive blood test. You don’t look forward to it, but once you’ve done it and spend time digging into the data and results, it can be quite interesting, and it can further motivate you to make lifestyle adjustments.
Even the ultra-rich need a plan. I think we’ve all heard the horrific stories of those that overspent their wealth; just google Johnny Depp or Allen Iverson bankruptcy.
BUT, some ultra-rich people spend too little: you could have been enjoying the finer things in life. Or as a philanthropist contributing and participating more in your favorite causes while you are alive on earth.
In Summary
Want to reduce or eliminate financial related stress? Simple. Get a financial plan and investment strategy and stick with it.
