Mark Twain once quipped that a cat that jumps on a hot stove won’t do it again. The cat also won’t jump onto a cold stove either.
That’s a thought that’s passed through my mind the past few weeks as the sudden increase in market volatility has changed perception about the safety and security of stock market returns.
Investing is a process. And it’s important to learn from events. But it’s also important to answer the right questions to improve going forward. Most investors won’t do that. They also might not put too much thought into what they’re invested in and why.
The end result of that is cashing out at a bad time when stocks are temporarily down. That ends up costing them the rebound—not to mention the future gains they would have seen had they stayed invested. Understanding how your portfolio did and how you reacted to this recent market volatility is crucial to your wealth going forward.
So how did you fare? You don’t need to tell me. Rather, you need to be honest with yourself. Here are the specific questions I’ve been asking myself—and ones you might want to mull over:
- Did you cash out as stocks hit a 5 percent decline from their all-time highs? Did you throw in the towel when stocks pulled back 10 percent, to levels last seen in the not-so-distant past of November 2017?
I hope not. That’s a sign that you’re only comfortable investing in stocks when times are good. Investing when times are bad, even if it seems like you have to hold your nose to enter into a new position, is where the best returns are made. Why? Because you get the best bargains when it seems like nobody wants to buy.
And if a small correction like the one we saw this month is any indication, handling a bigger correction in the future, to say nothing of a full-blown recession, is one you’re not ready to face yet. Forget a 2-week 10 percent decline and rally. In a recession, stocks will fall 30-40 percent (sometimes more), and true bear markets can last up to 18 months. That puts a lot of stress even on the most astute and professional investors.
But, that level of selloff means that there are a lot of buying opportunities that might not have been available before. That leads to the next question…
- Did you look at buying opportunities in stocks you like during the recent market selloff?
If so, give yourself a pat on the back. Recognizing that market selloffs are buying opportunities, not selling opportunities, are what separates the successful investor from the uninformed.
Given the speed of this market selloff, and the speed at which stocks have rebounded, even if you didn’t make any additions to your portfolio, you did well just making this move. Most, if not nearly all potential investments shouldn’t pan out. And most companies that slid with the market spiked right back up.
When it comes to buying opportunities, there are only two considerations: to add a new position to your portfolio, or to add to an existing position. In some market selloffs, adding to an existing position can be a great way to lower your cost basis on an existing position. That means when things turn around, that position will get back to profitability much sooner. And if it’s a dividend-paying company, you can get a higher yield as well.
- If you had a written plan, did you stick to it, or did you wing it?
I’ll admit, this is often where I tend to falter personally as an investor. I have a written plan that works out well for my 401(k), Roth IRA, and other buy-and-hold type investments. But I also understand the need to periodically put some play money into a trade.
To have my cake and eat it too, I have a trading account for options trades, small cap stocks, and other ideas that look interesting at the time. But I know it’s the play money, and it’s not infinitely refreshable. That balances out the need for a written plan, as well as being flexible enough to take advantage of the market’s volatility.
I also have a written plan outlining my reasons to sell. I’ll sell a company at either a profit or a loss if the company makes some kind of fundamental change that I’m not comfortable with. I’ll usually sell a company I own if they cut the dividend and I bought it for income purposes.
But I don’t believe in selling a company based on one-day news events that tend to drive markets in the short-term. If you don’t have a written plan, make one. When the market goes haywire, stick to the plan. You plan when things are smooth to better handle the rough weather.
- What changes do you need to make going forward?
If you were following an investment strategy like shorting market volatility, a trade that blew up the accounts of a few folks earlier this month, a change is definitely needed. Traders blindly shorting volatility were rightly creamed for not thinking through the risk-reward proposition of shorting a highly volatile derivative when it was already skimming along all-time lows.
Hopefully, the changes you need to make are more along the lines of adding cash to your portfolio to take advantage of further market sales in the future. Or using a conservative options strategy like covered call writing to smooth out an increasingly volatile market and earn some extra income on the side.
If you don’t regularly ask yourself how you’re doing—taking a page from the late New York mayor Ed Kotch—and give yourself an honest accounting, it’ll be difficult to succeed as an investor.
Don’t beat yourself up over any answers where you feel you’ve fallen short. This mini-market correction can be a great learning opportunity and a chance to improve your future returns if you let it.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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