As we end 2016, with the recent surge of stocks and market indices it’s helpful to remember that while we can never predict the short term movement of prices, we can be sure that the market will move in cycles over time. It’s a given that at some point we will see declines of 10%, 20% or even more – it’s an inherent part of how markets work.
Since we know this will happen at some point it’s helpful to remember that this volatility produces future returns. That is, when stocks decline the going forward returns for investors increases. Just remember this January – the worst start for US stocks in recorded history. That produced a buying opportunity for those willing to act.
In this post Normal Accidents, analyst Michael Batnick points to repeated cases of major price declines over the past 100 years, all while stocks are up significantly in the long run.
Here are ways he points out that individual investors can prepare for a downturn (emphasis mine).
- Never put yourself in a position to be a forced seller.
- Always keep enough cash to survive a rainy day, or rainy years. Do not worry about it being a drag on your returns. The drag is nothing compared to the permanent damage of selling after a deep drawdown.
- Everything looks good in a back test. Unfortunately there is no such thing as a front-test.
- Be honest with yourself. Are you taking too much risk? Expect U.S. stocks will experience an intra-year drawdown of 15%.
- Think in numbers, not percentages. If U.S. stocks fall by 30% or more, and I promise they will eventually, ask yourself if you can handle that? If you have $1,000,000 invested in U.S. stocks, a 30% decline means you will witness $300,000 disappear. I repeat, $300,000. If you don’t have the ability to sit through that, it’s better that you recognize it and do something now rather than fool yourself into thinking you can.
When this time inevitably comes it will still be painful, but mentally preparing yourself and seeing the future upside is important. Having a cash reserve can help you take advantage of the situation. If stepping in to buy is too hard (it’s not easy) having your stocks/funds set to automatically re-invest is one way to take advantage of lower prices.
Happy New Year!