Learning Lessons from the Market Correction Helps Us Become More Disciplined Investors
The stock market’s plunge at the outset of the Covid-19 pandemic, when the S&P 500 index plunged 32% in five weeks, shook up a lot of investors and reminded all of us to refresh our memories of previous “lessons from the market correction.” That scary episode reinforces a timeless lesson for investors, regardless of the reasons for a selloff.
On Feb. 20, 2020 the S&P closed at 3,373, having risen 24% in 12 months. However, the evidence that the Covid outbreak would become a serious global problem had reached a tipping point. The next day, the index began falling steeply; it would bottom out at 2,192 on March 23rd, and close at 2,237 that day, for a stunning loss of 33.7% in just 22 trading days!
While the shakeout rattled investors far and wide, the only permanent damage was to those who lost their nerve and pulled their money out at the wrong time, turning paper losses to real ones. Like all bouts of market volatility, the Covid panic underlined the importance of remembering the previous “lessons from the market correction” and having an investment plan and sticking to it.
By mid-August, with the world’s best minds hard at work developing vaccines, and with global governments providing massive financial support to shore up economies, the S&P had erased its losses. Like a roller coaster, the market had taken its participants on a stomach-churning ride and deposited them right back where they started out. By the end of 2021, the S&P was about 40% above its pre-pandemic high.
Remembering Lessons from the Market Correction Helps Us Become Better Investors
Ultimately, the only investors who sustained serious setbacks were those who panicked and sold as the market fell. Like roller-coaster riders, the investors who had learned earlier “lessons from the market correction” of prior investment cycles stayed on plan and ended up just fine ― if a little dazed.
Suppose that on Feb. 20 of 2020, John Q. Investor owned a $1 million portfolio identical to the makeup of the S&P. Let’s say that on March 23, with the index down about 35%, John had no long-term plan and had lost sight of why he was invested and cashed out in an effort to protect his money.
John’s emotional response would have trimmed his $1 million to $650,000. And that would have hurt him in a second way. Because John now had a smaller base of capital to invest, he’d need to earn nearly 54% – not 35% – to grow his portfolio back to $1 million. That means that by the time patient investors had recouped their losses, John would still be catching up.
Clearly, our hypothetical investor would have been better off had he made no changes to his investments during the selloff. Indeed, he would have done well to buy stocks as others were panicking and selling them cheap.
Undisciplined behavior like John’s is rooted in our nervous systems. Like it or not, we have evolved to enrich ourselves whenever possible – with food, money or resources. And when it comes to perceived danger, we’d much rather be safe than sorry. Indeed, studies have shown that investors experience more pain from investment losses than pleasure from investment gains. And that helps to explain why so many investors sell in the midst of temporary trouble.
We humans can’t rewire our nervous systems, of course. What we can do is remember the lessons from the market correction or two that we’ve lived through and use the tools available to us to exercise better investment discipline. And the two best tools may be a financial and and investment plan. Having these plans always results in mental preparation, which enables us to better resist our emotional impulses and make sound decisions.
Lessons from the Market Correction Remind Us of the Value of Our Plans
Financial plans help us to clearly identify goals and weather the twists and turns along the path toward those goals. Investment planning helps us learn the lessons from the market correction most deeply rooted in our mind to help minimize our behavior gaps as we move away from “running for cover” and “swinging for the fences” and toward the far more effective approach of compounding investment returns over time.
The planning process leads us to understand that long-term investing ― including opportunistic buying when others are selling out of fear ― can help us reach our goals more quickly and efficiently. Investing, like most everything else in life, is not that difficult. What makes it difficult is recovering from all of the mistakes we make — and planning helps us to avoid those mistakes.
If you would like to develop a better understanding of the lessons from the market correction you best remember and develop and implement goal-based planning for you and work with an advisor who cultivates your discipline to the plan, we may be able to help.