Young Canadian Investor #7 — Some Context to Minimize Panic
Arguably, the hardest part of investing for the long term in individual stocks as well as broad stock index funds—this includes funds that track the Total US Market, Developed International Markets, Emerging Markets, or the Global Stock Market— is keeping your psychology in check during market extremes.
When funds have been going up for a handful of years, most of us think the trend will continue and want to buy more shares. Even though we have to pay an increasingly high price to do so.
When funds have been dropping for a long stretch, most of us figure it’ll get worse and feel we should sell. Even though prices haven gotten cheaper and thus more appealing.
Why do we act like this? Human nature.
How do we fix it?
One. By setting a range for how high and low stock markets can go, as per the historical record, to get an idea of good lows to buy more of, and good highs to dollar-cost-average into until prices improve. Selling investments should be limited to the reason you invested in the first place.
How much can markets rise before a recession knocks them down to fair value? Australia’s stock market went more than a quarter century without one.
How much can a country’s stock market drop, and how soon? Eighty percent is a reasonable worst-case scenario. This happened in the US over two years in the late 1920s and early 1930s with the market taking over 25 years to recover. It happened again, this time over a couple decades, during the double-digit inflation of the 1960s and 1970s.
Historically speaking, though, any time a broad index is down double digits (over 10%) constitutes poor performance and thus a buying opportunity/sale/good deal. This with the knowledge that it could drop another 50% or more and get that much more affordable.
Two. By remembering that, excluding problems with the fund’s management or issuing company, a broad market index fund going to 0 would require the industrial complexes of the countries it tracks to go out of business too. And it’s next to impossible for that to happen, whether in Canada or Spain or South Africa. Barring an apocalypse or investment company bankruptcy, dips in your index funds’ prices per share will eventually recover. It may take many years, so it’s up to you to ensure an appropriate time horizon.
Three. By holding firm that, to benefit from investing in stocks over the long term, i.e. make money, you have to invest regularly and stay invested—continuously— in a globally diversified portfolio for a minimum of five years but ideally for a few decades or more.
That’s essentially how you watch your index funds drop in value without panic-selling to avoid the stress. Easier said than done? Perhaps.
But when you compare how inflation currently cuts what you can buy with the money in your savings account by 2% per year, every year, with a globally diversified portfolio’s long-term expected return of 7% per year, giving into fear looks a lot like very slowly going broke.
You can learn more by reading my introduction to investing for young Canadians.
Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.