How to Stay On the Sunny Side in a Cloudy Market

The year has gotten off to a difficult start in the stock market. The major averages plunged as much as 10%, which is the common definition of a correction. Now the speculation is that a bear market (one that falls at least 20%) will follow. How you view these events is a matter of your personal perspective.

That perspective includes the time frame for your investments, your attitude, and your ability to adapt to a situation regardless of whether or not it is to your liking.

A common problem is “time distortion.” While we may claim to be long-term investors, many people react to the panic-inducing headlines and televised hyperbole and believe that they are about to suffer enormous losses unless they do something immediately. But the impulsive rush to sell betrays our long-term focus in two ways.

First, that impulse usually comes when stocks are already down by a noticeable amount, when we would only be locking in the losses and avoiding any subsequent gains. Second, we allow our well-founded judgment of a business’s excellence to be replaced by the temporary madness of crowds, effectively accepting a failure that is undeserved. Worse still, we fear that our long-term focus is a mistake, distracted by the seeming wisdom of short-term traders who claim to have “gotten out in time” to avoid big losses. The truth is that they can make that claim only because they are always jumping in and out of the market, which means that they have also missed out on much of the larger gains that accrue over the long term.

The right attitude must be developed over many years. It’s a learning process that starts with making up our minds to be optimistic, rather than pessimistic. Bad things are going to happen from time to time in the stock market, but equities tend to go up a lot more often than they go down, so letting the pullbacks cloud our judgment will not accomplish much, except to help us avoid building wealth over time.

Recognizing that time is our best ally, then, is a key to maintaining that optimistic attitude. That helps foster our ability to adapt to the situation. When we decide which companies represent the best businesses to own, we then must consider stock price and decide whether to buy or wait for a better price. So when a stock goes on sale, it should be a happy occasion, not a reason for panic.

Unless something specific has happened to make a business less attractive, buying – not selling – that business’ stock is the proper course, and it should be that much easier if we are using dollar-cost averaging, rather than making a lump-sum purchase. And reinvesting dividends allows us to take advantage of sale prices automatically. So we can consider down markets simply as a test of whether or not we can maintain perspective and execute our long-term plans.

Source: Kiplinger, by Vita Nelson