First off, I have no idea what is the going to happen today. The market will open up ugly. For example the Nasdaq 100 futures are limit down. Some sort of corrective action in the market should not come as a huge shock. We have written a couple of posts over the summer talking about dealing with drawdowns. For example:
Who knows when the next 10% correction, or 20% bear market will occur. I am sure Jesse Felder would like the prior to happen sooner rather than later. In any event it is good to remind ourselves of these facts before they occur rather than during the drawdown. Because when the actual drawdown happens you will have other things on your mind.
Every valid investment strategy goes through periods of underperformance (relative), or drawdowns (absolute). The question is how you deal with it. One key characteristic of frustrated investors is that they jump from strategy to strategy. The first sign of weakness forces these weak hands to jump ship at just the wrong time. In short, following a strategy is easier said that done.
In that light I wanted to highlight what some smart writers are saying that should put into perspective what is going on today. Josh Brown at The Reformed Broker talks about the importance of fear. He writes:
Fear is the most critical, functional cog in the investing machine. It’s got to remain present and front-of-mind in order for there to be any future upside for investors to capture. Long-term investors should cheer when fear is reintroduced into the markets.
Ben Carlson at A Wealth of Common Sense also notes how our fear of losses, or loss aversion, affects our ability to invest successfully. He writes:
Crashes, corrections, drawdowns, losses, system resets or whatever you want to call them are a feature of the financial markets, not a sign that they are broken. These things have to happen every once and a while for the system to function properly and wash out the excesses. It makes sense to learn from them and you definitely have to mentally prepare yourself for dealing with losses. But the infatuation with down markets can be taken too far when loss aversion begins to cloud your judgment.
James Surowiecki at the New Yorker weighed in this morning as well. He notes how these times are nerve-wracking for investors and test their mettle. He writes:
The price of a long-term perspective, in that sense, is sometimes short-term turmoil. And while it’s undoubtedly nerve-wracking to watch billions of dollars in stock-market wealth vanish in a matter of minutes, it’s actually a good thing that investors are testing their expectations against reality and re-setting prices accordingly.
If you are on a ledge this morning it probably means you have miscalculated your tolerance for risk. When the dust settles you can revisit your portfolio strategy and risk expectations. In the mean time if you have to do something this morning check out Josh’s post with a with a timely strategy for gap-filled markets.