Young investors can treat the sharp drop in stocks this year as a buying opportunity, and older investors may not be able to wait for it to recover.
Most of the investors in the markets are now wondering how to deal with the current bear market, but the sad thing is that the possibilities of stagnation may mean a long-term downtrend that does not know its bottom, and inflation rates may eat the purchasing power of money even if it succeeds in achieving some positive returns.
With the US Federal Reserve raising interest rates by 0.75 percentage points last week, coinciding with a rise in inflation at nearly 9%, US stocks have fallen by 22% this year; Bonds fell by 11%.
As a result of these losses, Wall Street Journal “Smart Investor” columnist Jason Zweig offers a set of advice, especially if the downturns last longer.
How successful you will be as an investor out of this recession, he said, depends in part on the length of your investment horizons, but more importantly on how you respond.
While some see that the reactions depend on the current dominant human behavior with the feeling of the need to sell at the moment, before your remaining wealth is destroyed into small pieces, but the other side freezes the mind from thinking and pushes people to avoid taking any action that worsens the situation.
Opportunity to buy
While some brave investors see this drop as an opportunity to buy more assets at lower prices, others are happy to get a decent return on cash after more than a decade of near-zero returns.
It is important to remember that US stocks, even after this year’s setbacks, have been gaining roughly 13% annually on average over the past decade.
More important than the decision to buy or sell right now, are some permanent behavioral changes that can keep you on the right track.
According to the “Smart Investor”, “It is useful, whenever the markets become anxious, to look at historical precedents, how bad things can get?”.
In his article, the columnist pointed to the worst-case scenario that American investors fear most, which is a repeat of stagflation between 1966 and 1982, when economic growth was choppy, inflation remained in the double digits for years and stocks went nowhere at all.
At this time, the S&P 500 index closed, specifically on February 9, 1966, at a record level of 94.06 points, and after more than 16 years, on August 12, 1982, it reached 102.42 points.
Corporate profits after inflation have also shrunk by 15%, according to data from Yale University economist Robert Shiller.
Although the companies paid a generous dividend, which amounted to nearly 6% by the end of the period, they were completely devoured by inflation.
It was an ordeal that made individual investors an endangered species,” the columnist described.
In 1970, according to a survey by the Federal Reserve Board of Households, 25% of families invested in stocks; By 1983 the percentage had shrunk to 19%.
Between 1970 and 1981, total assets invested in mutual funds shrank to $41 billion from $45 billion.
Although many investors gave up in those bleak years, it is not possible to be certain of the result achieved by the investors who kept their plans to buy shares, especially the “automatic investment” plans, which enable individuals to follow the buying strategy in regular increments over long periods, It was not widely used in those days.
For example, if you were able to invest $100 in US stocks in each of the 199 months from February 1966 through the end of August 1982, your cumulative investment of $19,900 would have been $18,520 after inflation, according to research firm Morningstar.
By 1982, purchasing power of $19,900 in 1966 had shrunk to about $11,000, according to an estimate by Nick Maggioli, COO of Ritholtz Wealth Management in New York and author of Just Keep Buying, a book on automated investing strategies.
While automatic investing cannot guarantee a positive outcome, the good thing about it is that it imposes behavioral discipline on investors.
While investors who spend all their money at once are likely to regret a bear market trend, those who invest consistently with the ticking of the clock tend to worry less about buying at the wrong time, making it easier to stay on track.
And, according to Zweig, sticking to a strategy is especially important for young investors with long horizons. The plan can help them realize that falling markets are not a disaster, but an opportunity to create wealth.
To underscore this, legendary investor Warren Buffett advises investors to think of stocks like “burgers.” If you love them, you should wish their prices lower, not go up, and the younger you are, the more meals you will have in the future.
Buffett coined his advice another way in 1997, saying, “Only those who are going to sell stocks in the near future should be happy to see stocks rise.”
“I would say the problem with stocks is that they have the letter T, so if they were called socks, people would treat a 20% drop in price not as a sell signal, but as a sale,” he explained.
“When socks get 20% cheaper, don’t rush to throw away socks you already own, but check your sock drawer to see if you need a few more pairs,” he added, emphasizing that “young investors should treat stocks the same way.” .
By historical standards, stocks sure still aren’t cheap, but young people looking to build wealth over long periods should be happier buying stocks after this year’s 20% drop than it was during the 114% rise the previous year.
The good news, for younger and older investors alike, is that returns on income-generating assets are on the rise.
“Throughout history, the way most people thought about wealth was not about how much you have, but in terms of how much income you can produce,” said James White, chief executive of Elm Partners Management, an investment firm in Philadelphia.
With interest rates rising, the so-called real yield on long-term Treasury Inflation-Protected Notes, or TIPS, has risen rapidly to 1% this year. This metric tracks what these securities pay investors in excess of expected inflation. 2022 started at -0.43%.
So White points out that a $1 million investment in TIPS bonds can now generate $10,000 in annual income, after inflation, that is essentially risk-free. Until last April, the same million dollars could not have produced any inflation-adjusted income at all.
Finally, Zweig advises, that during a bear market, it is necessary to spend less; “Financing your lifestyle by selling assets that have fallen in price is painful.”
Ultimately, whether the markets rebound quickly or slowly is up to the bears, and how you respond is up to you.