What if the Stock Market Makes You Nervous?

A couple of readers have mentioned that they're nervous about the stock market's recent volatility. I've read similar concerns on other blogs and financial news sites. People are worried that the stock market's performance over the last month portends an impending bear market, and they don't know what to do.

Reading these concerns reminded me of Why Smart People Make Big Money Mistakes, which I reviewed last week. In the book, the authors discuss panic selling as a common financial pitfall. When people suffer from loss aversion, short-term losses cause them to sell investments prematurely, which can lead to greater pain:

One of the most obvious and important areas in which loss aversion skews judgment is in investing. In the short term, being especially sensitive to losses contributes to the panic selling that accompanies stock market crashes. The Dow Jones Industrial Average tumbles (along with stock prices and mutual fund shares in general), and the pain of these losses makes many investors overreact: the injured want to stop the bleeding. The problem, of course, is that pulling your money out of the stock market on such a willy-nilly basis leaves you vulnerable to a different sort of pain — the pangs you'll feel when stock prices rise while you're licking your wounds.

But what can you do if being in the market makes you nervous? You don't want to lose your money — what happens if the market continues to fall? If you feel trepidation about stocks, assess your risk tolerance. There are several online tools that can help you with this:

If your risk tolerance is low, then the stock market may not be right for you. Perhaps you should consider less volatile investments until you've researched the market's historic performance.

If you have a decent tolerance for risk and still feel nervous, pay less attention to market news. Again, Why Smart People Make Big Money Mistakes offers excellent advice:

Pay less attention to your investments. Horrors! How can we think such heresy. Don't worry, we're not advocating turning a totally blind eye to your hard-earned savings, mostly because nobody would listen: a recent American Stock Exchange study indicated that nearly 40 percent of young, middle-class investors check their investment returns once a week! And that's simply too often. The more frequently you check your investments, the more you'll notice — and feel the urge to react to — the ups and downs that are an inevitable part of the stock and bond markets. For most investors — frankly, for all investors who don't trade professionally — a yearly review of your portfolio is frequent enough to make necessary adjustments in your allocation of assets.

One strategy for minimizing fears is to buy and hold low-cost stock market index funds. Reduce the effect of market fluctuations by making systematic regular investments. This is what I intend to do when I've eliminated my debt — I'll schedule a regular monthly purchase of QQQQ (or similar index fund), automate the process, and forget about it.

In The Little Book of Common Sense Investing, John C. Bogle, the great pioneer of index funds, warns against attaching too much meaning to what he terms the “expectations market”, the guessing that investors — amateur and professional — make when trying to predict the market's direction. When we begin to focus on the short-term noise, we're speculating and not investing. Bogle writes:

There are bumps along the way in [investment returns]. Sometimes, as in the Great Depression of the early 1930s, these bumps are large. But we get over them. So, if you stand back from [a chart of stock market returns since 1900], the trend of business fundamentals looks almost like a straight line sloping gently upward, and those periodic bumps are barely visible.

The entire text of Common Sense Investing is a treatise on the virtues of index funds. Bogle states that “the case for the success of indexing in the past is compelling and unarguable”. He believes overall market returns may be lower in the coming decade, but that this actually makes index funds (with their low costs) more attractive, not less attractive.

If the road to investment success is filled with dangerous turns and and giant potholes, never forget that simple arithmetic can enable you to moderate those turns and avoid those potholes. So do your best to diversify to the nth degree; minimize your investment expenses; and focus your emotions where they cannot wreak the kind of havoc that most people experience in their investment programs. Rely on your own common sense. Emphasize all-stock-market index funds. Carefully consider your risk tolerance and the portion of your investments you allocate to equities. Then stay the course.

In other words: your best choice is to invest in low-cost index funds that mirror market performance, even during rough patches. If you are risk averse, then shift some of your portfolio to bond-market index funds. Maintain your investment strategy, no matter which way the market is moving.

Benjamin Graham once wrote: “The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.” It's not the short-term that matters; it's the long-term that's important.

Addendum: In the comments, Ogden points to recent commentary from Ben Stein on this subject. Also, Free Money Finance recently wrote about going against the flow. And here's more on the subject from Andrew Tobias.

More about...Investing, Psychology

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Sam
Sam
13 years ago

When the market goes down, we remind ourselves that our regular investments dollars will buy us more stock at lower prices. We also remind ourselves that Buffet and folks like Buffet made their money buying stock in companies when the stock was way down not when it was way up.

plonkee
plonkee
13 years ago

I couldn’t agree more. If the thought of your investments temporarily losing money is a problem, and you genuinely believe that between now and the time you want to access the money (e.g. retirment) they are going to go down, then you should not be invested in the stock market. Otherwise, who cares what they are doing, we aren’t day trading, we are investing.

Maitresse
Maitresse
13 years ago

Warren Buffett said, “Be fearful when others are greedy, and greedy when others are fearful.”

I check my investments daily, but I also have a high risk tolerance AND more money to invest. So I’m always looking for a good deal, and I’ve certainly been finding them the past few weeks.

I’m not investing in the stock market, I’m investing in individual companies. It’s a very different mindset.

Yves
Yves
13 years ago

Here’s something that helps me keep a big-picture perspective when the market moves quickly either way: I’ve set up a spreadsheet with my investment balances and trailing 5-year performance, plus inflation, and use it to calculate a future balance set for my planned retirement date. I further calculate what that balance will pay in monthly dividends at a conservative rate of return. When I update my balances I withhold judgment until I see the effect they have on those payouts. Regardless of how great the swing up or down, the effect is usually minimal over the remaining years I plan… Read more »

Dave
Dave
13 years ago

J.D. — thanks for helping put things in perspective … Dave Ramsey just addressed this same issue the other day. Rather than going right to listener phone calls, he began his show by trying to calm people down over their ridiculous fears re: the stock market. He explained how 100% of the 10-year-periods in the stock market’s history have made people money. In fact, I would encourage any “nervous” people to simply go listen to the opening of that show — just click “Listen Now,” then “Listen to the Show,” then “Archives,” then choose “Thursday, August 16.”

http://www.daveramsey.com/

Dave
Dave
13 years ago

Maitresse — I’m assuming you’re a professional investor, but Warren Buffett himself says that 99% of people who invest should do so in broad, low-cost index funds and not trade. In fact, here is a YouTube video of him saying that — just wait for the 1:10 minute mark.

http://www.youtube.com/watch?v=P-PobeU4Ox0&mode=related&search=

Folks, there is a reason J.D. mentions index funds almost every other day. Please listen to him; it is The Way.

Market Flavor
Market Flavor
13 years ago

It’s very hard for investors to watch their accounts drop day after day. But as hard as this is, you can really increase the returns of your portfolio by adding money to your beaten up strong stocks.

Most investors should make it part of their investing strategy to pull more out of their paychecks in a market downturn and add it to their retirement account.

Ogden
Ogden
13 years ago

If you are worried about the market, you should read the following by Ben Stein, especially if your idea of investing is letting you 401K do the work for you:

http://money.cnn.com/galleries/2007/fortune/0708/gallery.crisiscounsel.fortune/13.html

Chance
Chance
13 years ago

You mention that worried investors could pacify themselves by not actively watching their stocks. I actually do just the opposite. I track my portfolio every day in a spreadsheet. At the end of the day, I record the closing value of my entire stock market portfolio (just the total number, not individual positions). With each day’s values graphed, I can readily spot large movements and put them into perspective. For instance, with the recent market drop, my portfolio value went down about 11%. That’s a significant drop, but looking back I can see that in May/June of 2006, my portfolio… Read more »

Dave
Dave
13 years ago

Ogden — thanks a lot for posting that Ben Stein link. I love it when Stein says …

“The inert, lazy, couch potato investor (to use a phrase from my guru, Phil DeMuth, investment manager and friend par excellence) knows that despite wars, inflation, recession, gasoline shortages, housing crashes in various parts of the nation, riots in the streets, and wage-price controls, the S&P 500, with dividends reinvested, has yielded an average ten-year return of 243%.”

JenK
JenK
13 years ago

Where I’ve gained the most money in investments I’ve chosen is in stock and stock/bond blend index funds. Where I’ve lost the most money is in individual stocks. Not that they’ve all been losers; the Boeing stock I bought on 9/12/2001 has tripled and the United Technologies I bought on the eve of the Iraq war has doubled. But in sheer dollars, the biggest flub was taking my last employee stock option exercise as shares of stock. (The bulk of the money I invested came from stock options, but that was not something I was high enough in the company… Read more »

Starving Artist
Starving Artist
13 years ago

Hey JD — I made a slip up recently with my 401K. It’s not that the market made me nervous, but the result was a similar screwup. I realized I had way too much money in my company stock, so I checked with my work’s financial people and found out I could diversify (I was working under some odd assumption that I couldn’t diversify the company stock until I was 45!). Anyway, I immediately moved about 3,500, and then kicked myself, because the stock is at an all time low. Serious money loss!

joshuat
joshuat
13 years ago

@Dave @ Accidental FIRE, thanks for pointing out the Dave Ramsey Show, I was going to mention that here. I’ll followup with this: Members of Ramsey’s “My Total Money Makeover” site can download all three hours of the show, commercial free, and he had additional discussion and emails about this topic in the second and third hours on 8/16.

JenK
JenK
13 years ago

More to the point, I weather the slings and arrows of stock ups and downs with:

– The emergency fund is in savings and a short-term bond fund. That and the checking account is the only money I will spend in the next year.

– The money in stock index funds is Not To Be Spent for 25 or 30 YEARS. Therefore today’s fluctuations Do Not Matter.

Yes, I will probably need to revamp this in about 20 years. But at the moment it works quite well.

Aleks
Aleks
13 years ago

I’m pretty risk tolerant, but I don’t have the knowledge to invest in individual stocks. I recently sold my employee stock plan shares (the only individual stocks I owned) because it made me nervous to see it going up by 5% in one week for no reason. Even having insider information didn’t make me feel comfortable, so I’m moving the money to my funds which I check quarterly. When I look at other companies’ stocks, I have no idea whether their current price is under- or over-valued. Over all I think the stock market is still over inflated even with… Read more »

JenK
JenK
13 years ago

“will spend in the next year” — I’m not PLANNING to spend the emergency fund, but if I lose my job or get cancer, that’s what will get tapped….

VinTek
VinTek
13 years ago

“…the Boeing stock I bought on 9/12/2001 has tripled…”

Actually, the markets didn’t open on 9/11 and didn’t reopen until 9/17.

JenK
JenK
13 years ago

Thanks for the correction.

VinTek
VinTek
13 years ago

@JenK

“Thanks for the correction.”

No problem.

“Yes, I will probably need to revamp this in about 20 years. But at the moment it works quite well.”

Just curious. Do you ever adjust your holdings to maintain your planned asset allocation? It would make a lot of sense, particularly if your holdings are in an IRA or a 401(k). Also, you might consider tweaking your asset allocation every 5-10 years (depending on your age) to slowly start emphasizing capital preservation, vs. the capital appreciation. Just a suggestion.

Peter
Peter
13 years ago

I would never encourage someone else to be invested in something they are uncomfortable with, but they need to understand the tradeoff. If you would feel more comfortable only investing in bonds, CDs and money market funds you are going to need to invest A LOT more money, for A LOT longer to achieve the same end result as someone who is in the stock market. As long as you understand that, you should invest in whatever allows you to sleep at night. The more uncomfortable you are with an investment, the more likely you are to panic and do… Read more »

Nicole
Nicole
13 years ago

Its also a great time to buy if you fund your Roth IRA or IRA annually. Although I think the market is in for more losses so you might want to wait, but you can’t time the bottom!

JenK
JenK
13 years ago

VinTek – “Just curious. Do you ever adjust your holdings to maintain your planned asset allocation?” Usually what happens is that new investments go where we need to increase. And if there’s an investment we would not invest in today (individual stocks) then we sell it and reinvest. “Also, you might consider tweaking your asset allocation every 5-10 years (depending on your age) to slowly start emphasizing capital preservation, vs. the capital appreciation. Just a suggestion.” 🙂 I turned 40 last year, so I figured it was about time to do that. I also noticed the emergency fund – half… Read more »

42
42
13 years ago

Once I saw what was happening with the mortgage mess I sold all my equity positions (thanks AAPL!) and decided to play it safe and preserve capital in treasury ETFs. AAPL was the biggest part of my holdings and it tanked the next day. whew. the market will still be there when the roller-coaster ride ends. I would much rather preserve gains than be a passive investor and watch those gains go away. what’s the point? dollar-cost averaging only goes so far. passive investing cost a colleague of mine about 2/3 of his 401k in the tech meltdown. if he… Read more »

plonkee
plonkee
13 years ago

@42
The trouble with waiting for the roller-coaster ride to end is that it doesn’t.

The market is volatile, that’s one of the reasons that it is a good place to invest. It means that over every 10 year period there are likely to be severe drops and rises, the market often falls by large percentages but it also tends to rise by much greater percentages.

JenK
JenK
13 years ago

Re: tech bubble, no, Microsoft & Infospace stock haven’t regained (to use examples that affected me & friends). BUT, and this is a big but, my index funds have regained and increased enough to more than make up for those losses. Of course, it helps that I HAD significant money in index funds, and I hadn’t used a margin loan to finance my house, and so on…! Some of my other stock picks have done better – but I still sold most of them and am putting the proceeds into funds. Instead of having that money riding on 5 companies… Read more »

Corky
Corky
13 years ago

One way I’ve learned to avoid paying too much attention to my investments is to avoid looking at short-term charts. I use stockcharts.com, where the default is a one-year chart plotting daily changes. But I found that those charts are too “twitchy” for my long-term investing goals. So I started using long-term charts plotting monthly data going back as far as their database allows. This effectively filters out the short-term volatility and helps eliminate my tendency to overreact. Shorter-term charts, I’ve decided, are for day-traders and others who watch the markets obsessively and who don’t plan on holding an investment… Read more »

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