Two things to do when you are a stock market junkie

For more than a year it looked like the stock market could only go up, buoyed by the river of money flowing from the government. That illusion has been shattered in the past week.

The growing certainty that the Federal Reserve intends to raise interest rates, most likely as early as March, scared investors. On Monday, the Dow Jones Industrial Average climbed 1,000 points twice in a single day. It sank over 3%, then roared back to close with a profit. The stock rallied for the rest of the week with the S&P 500 down more than 9% so far in 2022 and the Nasdaq-100 index down more than 14%.

But what happens next is not the right question to ask.

In a speech in 1963, the great investment analyst Benjamin Graham said: “In my nearly 50 years of experience in Wall Street, I have found that I know less and less what the stock market is going to do, but I know more and more. More on what investors should do.”

You must do two things. First, put the recent volatility of the market in a long-term perspective. Then, recognize that what kind of investor you are matters more than what investment you own.

There is nothing unusual in the way stocks have risen over the past few weeks. That’s the calm of last year, when stocks rose about 28% but fluctuated with about two-thirds of their normal intensity, which was unusual.

Two factors had kept the stock up smoothly until this month: government policy and investment automation.

The Federal Reserve’s low interest rate stance and trillions of dollars in stimulus spending flooded the markets with cheap money. This led to a rise in the shares.

And, whenever the decline accelerates, financial advisors and retirement funds send automated buy orders that mechanically buy stocks as they fall below target levels. This has kept the shares from falling too far.

Such smoothness can create complacency.

“We go through these longer regimes of less volatility than usual,” says Joan Hill, head of research and strategy at CBOE West Financial, an investment-advisory firm in McLean, Va. Through.”

Sometimes called “risk compensation,” if nothing stood between you and those deep canyons, you’d make the hairpin turns of a mountain road faster than if you had strong guardrails. The feeling that the environment is safe can make you more comfortable taking risks.

Until last year, buyers of biotechnology, electric-vehicle and other “green-energy” stocks, cryptocurrencies and other hot assets concluded that their future growth would be so great that it was nearly impossible for them to overpay.

With many of these stocks selling for hundreds of times their expected earnings, or yet turning a profit, the prospect of the end of the Federal Reserve’s easy-money policy has gotten tough this month.

Yet it was the first time stocks have fallen in recent years. According to Dow Jones market data, the S&P 500 has closed down at least 1% for the day 448 times since the start of 2008. In 2020, stocks posted 45 times daily losses of at least 1%; On those five occasions, the stock dropped 5% or more.

Chances are, you barely remember those fall. Investors are exceptionally adept at revising their memories retrospectively. No one likes to admit to fear or to feel foolish or incompetent, so we polish our past; What was terrible then is not so bad now.

That’s why it is very important to understand who you are as an investor.

The falling markets set up a battle between your present self and your future self.

In 2022, your present self may suffer from anxiety and stress as you see the gains dwindling. Will you lose even more in the coming days and weeks as the stock keeps going up and down?

“Our distant future makes ourselves feel like separate people,” says Hal Hershfield, a behavioral scientist at the University of California, Los Angeles, who studies how time affects people’s decisions. It can be especially difficult to be in the mind when there are currently so many emotions — in the form of temptation or fear.”

Investors should care about the level of wealth: how much money they have. Instead, they care about changes in wealth: how much they just earned or lost.

How happy you would be if you had $1 million today depends largely on whether you gave $100,000 or $1.9 million last week. If you just made $900,000, having $1 million is thrilling. If you just lost $900,000, then having that same $1 million will fill you up. It’s only natural.

Evolution has made us this way. Change, rather than wealth status, was important to our hunter-gatherer ancestors. Even the slightest reduction in their food stock propelled the clan to action. No wonder bad events and consequences and possibilities are bigger than good ones.

Now imagine that your future is looking at you from 2032 or 2042 or 2052. Will you remember the fear you felt in January 2022? (If you don’t believe me, see if you can describe or even remember an investment decision I made in January 2012. I’ll wait.)

When you buy or sell a stock based on short-term market turmoil, the person you are trading with is your future. Remember: There must be a winner and a loser in every trade. So who’s getting the better deal?

If you have decades more investments ahead of you, your future self is likely to be annoyed – or even materially impaired – at the haste done now.

If you’re retired or about to retire, your future self may be happy that you’ve reduced the risk if the stock subsequently declines. If you are the kind of person who cut stocks in early 2020 or in 2008-09, the same is true.

When you send money from your present self to your future, “it’s a road several hundred miles long, full of potholes and icy patches and mountain passes,” says William Bernstein, investor and financial historian at Efficient Frontier Advisors in Eastford, Conn. it is said. You can easily slip off the road unless you drive very slowly and carefully.”

He adds, “It is better to be too conservative and end up with a few dollars lower than to reduce your tolerance for risk and end up with downside panic and selling.”

Keeping your future in mind also means you have to embrace uncertainty.

By historical standards, stocks are far from cheap at 40 times their long-term average earnings, adjusted for inflation, according to data from Yale University economist Robert Schiller. This is the highest in more than 140 years.

But for much of the past 30 years, by this same measure, stocks have been significantly overvalued. If you had left the stock in 1992 and stayed out since then, you would have missed out on a bonus; Shares rose an average of about 11% annually over those three decades.

One reason for the high returns of stocks in the long run is to compensate investors for the current risk of losing at least half of their money in the short term.

The prerequisite of being a long-term investor is knowing whether you can accept that uncertainty.