Should You Sell After A Stock Market ‘Correction’?
The FTSE 100 – or the Footsie, as you will sometimes see it written and pronounced – is an index that measures the performance of the shares of the 100 largest companies listed on the London Stock Exchange, sometimes refered to as the LSE. It measures the daily share price performance of those 100 firms.
On April 28th 2015 the FTSE 100 stood at 7,104 points, however by August 25th it had fallen to 5,898 – a fall of 1,206 points / 17% (at the time of writing this, it’s standing above the 7,000 mark).
Financial professionals generally describe any decline of 10% or more from a previous peak as a ‘correction’, although it’s unclear what investors should do with this information.
Should they seek to protect themselves from further declines by selling, or should they consider it an opportunity to purchase shares at more favorable prices?
Timing
Market timing is a seductive strategy.
If we could sell shares prior to a substantial decline and hold cash instead, our long-run returns could be exponentially higher.
But successful market timing is a two-step process: determining when to sell shares and when to buy them back.
Avoiding short-term losses runs the risk of avoiding even larger long-term gains. Regardless of whether share prices have advanced 10% or declined 10% from a previous level, they always reflect the collective assessment of the future by millions of market participants, as well as the expectation that shares in markets around the world have positive expected returns.
Contrary to the beliefs of some investors, dramatic changes in shares prices are not a sign that the financial system is broken but rather what we would expect to see if markets are working properly.
The world is an uncertain place. The role of shares markets is to reflect new developments, both positive and negative, in shares prices as quickly as possible.
Investors who accept dramatic price fluctuations as a characteristic of liquid markets may have a distinct advantage over those who are easily frightened or confused by day-to-day events and are more likely to achieve long-run investing success.
David Goetsch, co-executive producer of The Big Bang Theory television show in the USA, has adopted a long-term view of investing, which he found transformational during the recent market volatility.
He describes his experience in the essay below.
His perspective is a testament to the importance of having a strong philosophy and underscores the value of being educated to how market cycles work and being prepared for uncertainty.
I hope you enjoy it!
David Goetsch
Before I realised that markets work and adjusted my investment philosophy accordingly, I used to wish for a white noise machine to drown out the sound of market fluctuations and their accompanying hysteria.
I thought my mood and sanity would always depend on whether the shares I had chosen were trending up or down.
To me, investing in shares was like playing roulette in a shady casino. The financial crisis of 2008 only validated what I felt I could count on for sure – that everyone loses, eventually.
I would never be able to predict when or how, which meant that I might as well keep my retirement money in cash because what I lost to inflation was less than what I would lose in the market.
Everything I read in the media or watched on TV stoked my fears. Even if the sky wasn’t falling, I knew that it was only a matter of time.
I feel completely different today. I understand that it’s not all or nothing. Academics have shown that, over the long haul, the stock market is the best place to get a long-term return. Research has also shown that I can’t time the market or pick share winners better than randomness.
So I don’t.
I’m a long-term investor in the stock market. I don’t care about the ups and the downs of a certain day because my retirement is over 20 years away.
I don’t seize on the possibility that this is a good time to buy or sell something because I know that I can’t time the market.
I’m also not looking at an individual company that might create a unique opportunity given world events because the funds I buy hold thousands of companies.
I’m focused on the things that will really impact my long-term financial future:
- Spending less; and
- Saving more.
These are two things I can control (unlike when the Fed is going to raise interest rates).
Journalists don’t write front-page articles about the automatic monthly contribution I make to my kids’ college fund.
For every hot share tip that I receive, I can remind myself about the efficient market hypothesis.
The best thing about all of this is I managed to get off the emotional rollercoaster that many investors are trapped on – the same one on which I used to live.
Even in 1987, when I was in high school and didn’t have any money in the market, I found myself poring over the business section of the New York Times, like a rubbernecking commuter trying to get a better look at the car wreck on the side of the road.
Now I would rather spend time with my kids. I don’t know what the future holds. But I feel good knowing that I’m working on the things I can control instead of worrying about the stuff that I can’t.
Take Action
We’ve talked about it before – whilst it’s actually quite difficult to totally avoid the media’s scrutiny of what’s going on in the stock market, make sure you treat it as ‘noise’ and be aware that the media’s purpose it to feed their audience with news that will worry them.
Always remember that your long term financial plan (you do have one, don’t you?) is what should guide your future investment decisions, not the media!
- Invest for the long term
- Diversify (ie don’t just hold a few shares)
- Spend your time enjoying life, not worrying about areas you have no control over