How to gird yourself for the next stock market correction – MarketWatch
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The stock market appears headed for one of those points again when investors lose money, and a lot of it.
Sure, the day-to-day moves of the market can cost investors at any time, but this is more about the correction, downturn or something bigger that many experts feel is on the horizon.
In those times of heightened market tension, investors lose ground due more to their own behavior than whatever the market dishes out. So preparing for the dangers that may be closing in could help investors get through the drama with minimal pain.
The 2015 Quantitative Analysis of Investor Behavior from DALBAR Inc. was released last week, and it showed that in 30 years of monthly data, the worst performance for individual investors came at critical points, when the market was facing a severe decline or surging back from a tumble.
That’s saying something because the DALBAR study historically has shown that average investors stink at timing their purchases in virtually all market conditions.
It’s an old story, one known for decades now mostly because of DALBAR, where investors too often buy funds after a hot streak, and sell when the pain of a downturn becomes too much; as a result, they buy high and sell low, and it’s no surprise that in every 12-month period over the last 30 years the results investors got from mutual funds badly lagged that of the issues they owned, as well as the broad market.
‘Investors are a little bit like people who take a job, have a bad day at work and decide to quit’
Lou Harvey, DALBAR’s president
Over those 30 years, for example, the average annualized investor return in an equity fund was roughly 3.8%, while the Standard & Poor’s 500 Index SPX, +0.28% generated gains just north of 11%.
Perhaps most important, however, is the time frame when equity investors most badly lagged the index.
It was October 2008, at the start of the financial crisis, when equity investors lost more than 24%, or roughly 7.5 percentage points more than the broad market.
The next greatest monthly underperformance was in March 2000, when the index gained 9.8% but the average investor captured less than 3.8%.
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“What you are dealing with is a reaction to the market as opposed to a planned investment strategy,” said Lou Harvey, DALBAR’s president. “Investors are a little bit like people who take a job, have a bad day at work and decide to quit. That’s what we’re dealing with [in most market downturns], a bad day at work, and then some people who are quitting, which is why the numbers show up really so ugly.”
The problem isn’t just the lagging returns and the bad timing, it’s the compounding effect from missing out on the good numbers. When you look at returns over time, Harvey noted, the periods where investors underperform the funds they own or the indexes they are benchmarking with winds up “having a material effect on their portfolio for years or for a lifetime.”
Harvey suggested that investors need to prepare for bad times, and recognize that short-term downturns and most day-to-day headline events that move the market have very little impact on an investor’s long-term portfolio, “and you should shut your eyes, take a drink of water and move forward.”
But what is most critical is how you react in the heat of battle.
While the bull market has gone strong for more than six years now, downturns and corrections have not been outlawed or repealed. Trouble will come, as it does in all market cycles.
Harvey noted that investors should be looking at their portfolios now to see what it would take to scare them out the next time the market suffers. If funds have been laggards and disappointments, there’s no reason to wait for a correction to make a change; if funds have been winners, rebalancing the portfolio would capture some of the gains and make the portfolio better balanced for what lies ahead.
If you are unhappy with a fund now, when the market has been up for so long, it may be time to make changes. Chances are, you have a bad fund, more than you are reacting to whatever the market does.
Waiting to prepare for the battle is what leaves most investors making moves at precisely the wrong time, when the market has stirred up their emotions at a point when they might be better off leaving their holdings alone.
“Ups and downs are a normal part of the market,” explained Karl Mills, president of Jurika, Mills & Kiefer, a San Francisco-based investment advisory. “You want to spot the areas of long-term growth and get in the way of those and spot the areas of long-term challenge and try to stay out of the way of those. It sounds simple … but one of the hardest things is to do nothing and let the portfolio do its thing. If you have good investments, let them work for you over time.”
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How to gird yourself for the next stock market correction – MarketWatch
