A wild roller coaster ride might be an apt description of the stock market drop experienced in the last few weeks. Using the S&P 500 Index as a proxy for the market, stock prices (also called share prices) tumbled nearly 20% in the last three months, with half of that fall taking place in December. Understandably, many people are nervous and even panic-stricken watching part of their wealth get wiped out. But personally, the recent stock market drop doesn’t faze me and it even kind of excites me.
In this week’s blog, I share with you five reasons why the recent stock market drop doesn’t faze me and why it even kind of excites me.
I Save Money in Low-Risk Assets
Many people use the words saving and investing interchangeably, saying that they want to save money for the future. There is a certain similarity between saving and investing because they both require that you forgo spending money today so that it will be there tomorrow. But that’s where the similarity ends.
When I save money, I put it aside in a safe place where it can be accessed easily. Saving is for those unexpected expenses that always happen in life, like my broken washing machine last April. And for known upcoming expenses like my son’s wedding in February and for a summer vacation.
At the moment, I have a cash cushion in our checking account to cover two months’ worth of living expenses. I keep a big cash balance because short-term interest rates in Israel are incredibly low at the moment and the banks pay almost nothing for deposits. It’s not worth it to me to put some of the cash into a bank deposit. Even though I might earn a few agurot (pennies) of interest on a deposit, I’ll have to invest time to check my bank balance every day to ensure that I don’t go into overdraft.
In addition to our cash cushion, we set money aside in low-risk, short-term assets like treasury bills. I have enough money set aside to cover known expenses and reasonable unexpected costs during the next twelve months.
Read more: 5 Ways to Save Money in 2018
I Invest in Stocks
When I invest money, I put it to work for me, expecting it will grow over the long term. I expect my investments to provide higher returns than savings. And I expect that those returns will be generated over a relatively long period of time – generally five to ten years, or more.
But I also recognize that in the short-term, my investments can weather a stock market drop and falling prices. Since I don’t want to be stuck in a situation where I have to sell my investments at a loss to cover short-term spending needs, I separate my investing from my saving.
Even though the stock markets have dropped recently, I believe that the stock market is an incredibly safe and stable place to invest money long-term and to build wealth. Over the last 90-years, the average annual return of the US Stock market has been more than 11%. This time period includes the Great Depression, Black Monday (Black Tuesday in Australia), the Dot-Com Crash, and the Global Financial Crisis in 2008, among other downturns.
Let’s take a look at the chart below:
This chart shows that stock market returns can fluctuate greatly over short periods of time. The best 1-year return, +52.6%, occurred in 1954. The worst 1-year return was recorded in 1931, -43.8%. As a comparison, the US stock market dropped by only 36.6% in 2008.
As I invest in stocks for longer periods of time, history tells me that I become increasingly likely to enjoy positive returns. The range of average annual expected returns narrows and ultimately turns positive – even in the worst case. In other words, with time, the stock market becomes less volatile and more predictable. So while my stock investments might be getting a serious beating right now, I have every reason to expect that in the long term, they’ll be positive.
In addition, I diversify my stock portfolio (see below) by owning stocks of US and non-US companies. And I buy ETFs (Exchange Traded Funds), collective investments that hold hundreds and even thousands of different stocks.
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I Diversify My Investments
You’ve probably heard that you shouldn’t put all your eggs in one basket. I agree! To spread out and diversify our risk, we own bonds and real estate in addition to stocks.
The prices of all investments – stocks, bonds, real estate, gold coins, etc. – fluctuate over time. But they don’t fluctuate by exactly the same magnitude at exactly the same time. In statistics, we say that they’re not perfectly correlated. In everyday language, I say that some investments ‘zig’ while others ‘zag’. By owning a variety of investments, I reduce the risk that everything will drop together.
As of this writing, our investment portfolio looks like this:
I have an investment plan
To build long-term wealth, I follow a disciplined investment plan. I’m a little below our 70% target allocation to stocks right now due to the recent stock market drop. But I bought some stocks (on sale!) last week and I placed a limit order to buy more at lower prices! I like using limit orders. It means I don’t have to stay glued to the screens all day long watching which way the market goes.
I manage my mindset and monitor my thoughts
Life and Business Strategist Tony Robbins says that 80% of success is psychology and 20% is mechanics. If you don’t have the right psychology, i.e. the right mindset, then you can learn the strategy, but you won’t apply it.
Applying this concept to investing means creating a long-term investing plan and staying level-headed when prices fall.
This is how it works in real life:
When the stock market drops 10% or 20% or more, a lot of people get really nervous. Understandably, they worry that their wealth will be wiped out. They think ‘oh my gosh, what’s happening; this is really scary.’ Then, letting their emotions get the better of them, they panic and sell so they don’t lose everything.
Fear is one of the two primary saboteurs of investing success. Greed is the other one.
When I see the markets drop, I think ‘oh, prices are lower, we’ve been here before; this is the down part of the stock market cycle.’ In fact, rather than panicking, I get excited seeing stocks on sale at lower prices. I buy some more to rebalance my portfolio back to its target weight.
I want to be transparent and admit that today I make it sound easy. But back in the day, at the beginning of my investing career, it wasn’t so easy to think like this. It’s not fun watching an investment portfolio that was worth $100,000 ‘yesterday’ drop to $50,000 today. It can be even harder to watch a portfolio worth a million dollars collapse to half a million dollars. The larger the portfolio, the bigger the dollar loss, even when the loss is the same in percentage terms.
Read more: How I Got Started Investing
Developing a strong, resilient investing mindset takes time, continuous reinforcement and practice. Staying away from the media helps a lot. I recommend ignoring the financial headlines, turning off the news, sticking with your investment plan and getting on with life.
Wrapping it up
The recent stock market drop is a normal part of investing for the long term. While past performance is no guarantee of positive future returns, I believe that there’s a stock market cycle just like there are business cycles and economic growth cycles. Over time businesses will continue to develop, innovate, create and grow. Businesses small and large will continue to produce goods and services that people want and need to and buy. Man will continue to test and stretch the boundaries of technological innovation. So while we might see hiccups and volatility in the short term, I expect that the global economy will continue growing and stock prices will continue rising.
And that’s why the recent stock market drop doesn’t faze me and even kind of excites me.
Are you ready to take advantage of the recent stock market drop and start investing for success? My new book The $1K Investor: Simple, Smart Steps to Start Investing with $1K or Less is now available for pre-order on Kickstarter. Click here to support my campaign and order your copy.