So far in 2016, the markets have been dropping like crazy and many investors are scared of the stock market. I’ve been watching the news and they have done a good job at adding to the fear. They showed still images of traders on the floor that had despair written all over their faces. There was a graphic in big bold red numbers and an arrow pointing down that showed how much the average 401k plan lost each day. They even used music that you typically hear in a horror movie!
They say this is the worst 10-day start to the stock market in history. I checked my portfolio balances onPersonal Capital and saw that the stock market volatility so far has cost us over $20,000! But I’m not worried.
I know that many people – regardless of age – are scared to invest in the stock market. For the younger generation, their fear is rooted in the fact that just as they started to save and invest, the Great Recession blew up and they lost most of their savings when the markets tanked in 2008.
For the older generation, they are scared of the stock market because of the frequent crashes we’ve been experiencing in the past 20 years. But I am here to put all of this into perspective so that you can overcome your fear of the markets.
Understanding The Human Emotion of Fear
The biggest driver in being scared of the stock market is fear. As humans we learn fear at a young age, either through personal experiences or from others.
For example, I am afraid of big dogs because when I was younger, I was attacked by one. Now I am nervous whenever a big dog is around. This is a fear because of a personal experience.
You can also be fearful because of others though too. If you have any grandparents that lived through theGreat Depression, you know what I mean. Because banks went belly up and they lost their savings, they did not trust banks and tended to keep their cash hidden in their house. Many times, this fear took hold on their children and they too are fearful of banks.
When it comes to losing money in the stock market, but types of fear can occur. Either you personally lost money and are now fearful, and/or hearing how the media and “experts” talk with fear makes you scared of the stock market.
So how do you overcome your fears, regardless if they are related to the stock market or big dogs? You have to work at it. Yes it will take some effort on your part, but in the long run, it will be well worth it. Here is your step-by-step guide:
1. Understand your fear by noting where and why it entered your life. (For me, my event was the big dog attacking me. For those scared of the stock market, it might be because you lost a lot of money in 2008.)
2. Understand the impact the fear has on you. (For me, I tended to avoid big dogs at all costs. For those scared of investing, you might completely avoid the market altogether.)
3. Understand the potential outcomes of the fear. (For me, I could get attacked again, or the dog might just sniff around and want to be petted. For those fearful of investing, you could make money or lose money.)
4. Work on overcoming the fear. (When I see a big dog, I take a deep breath and remind myself that most likely, this dog is just going to sniff around and want some attention from me. While I still get scared at times, I no longer completely avoid big dogs. If you are scared of the stock market, you need to get to the point of understanding that the market goes up and down, and over time, tends to go up more than down. Education is key here.
Take the time to go through the steps above and when you are ready for the education piece for learning about the stock market, read on.
Key Things To Understand About The Stock Market
The following points are here to help you better understand and educate you on the stock market. While you will still have to put in some more work, hopefully reading the following puts you at ease.
Losses Hurt More Than Gains Feel Good
It is human nature to focus on the negative. It has been scientifically shown that losing $100 hurts more and is more memorable to us than winning or earning $100. So it is only natural that many people are still stuck on the losses they incurred back in 2008.
Personally, I can remember working for a financial services company and seeing the stock market (and my 401k plan) tank on a daily basis. But unlike most people that were scared, I was OK with it. Yes, it was disappointing to see the value of my 401k plan drop in half over the course of the year, but I knew that the market was going to eventually come back.
I stayed invested and kept putting more money into the market throughout 2008. By 2011 I had all of my money back and more.
Because I understand how the market works and that it rises more than it falls (see the chart below), I was not afraid of the stock market. I don’t focus on those losses from 2008, but rather I focus on how much money I have made since then. It wasn’t always this way, but it can be done, you just have to educate yourself about investing.
As you can see from the chart above, the stock market has had a positive return 72% of the time since 1928 and a negative return just 28% of the time. Stop focusing on the down years and focus on the years with gains.
Corrections Happen All Of The Time
A correction is when the stock market pulls back 10%, which is what happened last year in August and what is close to happening now again. How important is this? Not at all. Corrections happen all of the time. In fact, these drops happen on average of once per year! It might seem scarier now because we just had one. But they are a common event in the stock market.
Here is a chart showing you the frequency of drops in the stock market historically:
So before you get scared thinking that the sky is falling, just remember that pullbacks are a routine thing that happens all of the time in the market.
Don’t Overreact to Volatility
I want you to look at the graph below. Notice the huge decline in the early 2000’s (internet bubble bust) and then in 2007 (housing market bubble bust). Both times the market came back. And it will this time as well.
Now I want you to look at 1987 on the graph as well as 1990. Notice those two big drops in the dark blue line? Those were the stock market crash in 1987 and the recession in 1990. At the time, they were big events. But overall, they weren’t that bad and they don’t look that bad on this chart either.
I have two more charts for you to look at. Which one looks scarier to you?
Most readers will say that the first one is scarier than the second. The catch is that they are both of the S&P 500 Index from January 1984 to September 2014. The only difference is the first chart is looking at monthly returns and the second is looking at annual returns.
In other words, when you look at the short term, you see volatility – scariness. But when you step back and look at investing from a long term investing perspective, it doesn’t look that bad. That is your goal, to look at investing through long-term eyes.
Granted, short-term volatility is tough to stomach. Especially when it’s the big story on the news and everyone is scared. But this is the perfect time to buy. Think about it: when you go shopping, don’t you get excited when items are on sale? Of course you do. So why not get excited when the stock market drops? Stocks are simply on sale.
Stock Market Volatility: A Little Secret
Why does the media and Wall Street hype stock market volatility? Because when they do, they get you emotionally involved. When you start acting emotionally, you are bound to lose. When your emotions enter into the picture, you start to trade in and out of the market.
When you trade, you pay fees and commissions. This is how Wall Street makes money. Therefore, it makes sense to hype stock market volatility. The more they scare you, the more likely you will react and the more money they will make.
The same holds true for the news too. How do they make money? Through advertising. So the more compelling they make their stories, the more eyeballs they have watching. They then sell this huge viewership number to advertisers to make money selling ads.
Look at the below Google search I did about the stock market:
Those are some scary headlines. But remember, they are all trying to do the same thing: to get you to click on the link and visit to the site. Once there, the site is making money off you through the various ads on the page and even through subscriptions or other products they promote.
The Outlook Is What You Should Focus On
Instead of watching the news and getting caught up in their doom and gloom, keep things in perspective by looking at how things are doing, economically. Look at everything: companies are hiring, people are buying houses, the economy is strengthening, even slowly as some may argue. Things are not bad.
This means that there is a good chance the drop in the market is just a normal thing and not a sign of a continued drop that many fear mongers are claiming.
A Good Offense Is Your Best Defense
Lastly, your best defense against a correction or any drop in the stock market is to have a good offense. What does this mean? It means that you need to take the time to assess your risk aversion and build a portfolio that allows you to sleep at night, even when the market drops. If you do it correctly, drops like these will be much easier to handle.
Just make sure you understand that risk and reward are related. In many cases, when we do something to avoid one risk, we open ourselves up to another risk.
When it comes to investing in the stock market, many people avoid investing because of the risk related to it. But when you keep your money in cash, you open yourself up to another risk – reduced purchasing power. While your money will be safe, as in if you put $10,000 in the bank you will always have $10,000, your money won’t be growing and as a result, you will have less purchasing power due to the impact of inflation.
The point is, don’t think that there is no risk with avoiding the stock market. There is great risk with just keeping your money in cash as the money you saved will be worth less and less each year because of inflation.
Tips For Tuning Out The Noise
Many of the great investor use the term “noise” to describe the volatility in the stock market. Here are some great tips to help you tune out the “noise” yourself:
- Ignore the news: They are trying to get you to react. Turn the channel. Watch something else.
- Stop listening to “experts”: Many of the “experts” you see telling you the market is dropping to 200 or even rising to 100,000 have about as much of a clue as you or I. In fact, most of them are simply making the prediction to get your attention so you buy their book or pay to attend their seminar.
- Stop checking your balances: Don’t check your account balances every day, especially on days the market drops. Make it a point to look a few times a year. For me, I tend to look after the market rises a lot in a day (like 300 points). I find I focus on how much I made that day and not so much my overall balance. Seeing the gains for the day excites me and helps to keep me invested.
- Think Long-Term: While the market swings are large, make sure you focus on the long-term. Ask yourself if companies like General Electric and Apple will be around in 5-10 years. If you think they will (and there is a high probability they will), then ignore the short-term. It’s just a bump in the road.
Investing When You Are Scared of The Stock Market
So now that we have put this volatility into perspective, it is time to talk specifically of your money in the stock market. How can you still invest when you are scared of the stock market?
Your first step is to create a plan. You have to write out specific goals and plans for your money and why you are investing it. When you do this, you have a resource to look back on when the market drops. It helps to remind you why you are investing in the first place and this will help you to stay invested. In fact, it is such an important step, it is my first step for you in my stock market millionaire post.
Once you have your plan with detailed goals, you have to figure out your own risk tolerance. Doing this will allow you to be invested in the stock market and still sleep at night when the market drops. And it is going to drop. It’s the nature of the beast. Some days will be good days and some days will be bad days. But remember, over the long-term, the general trend of the stock market is positive. If it wasn’t, we’d all have lost everything a long time ago.
After you have your plan and your portfolio created, your next step is to stay invested in the market, both in good times and bad. You can’t sell everything and run when the market drops and then come back when it goes back up. You have to stay invested.
In other words, you cannot time the market. No one knows when the market will drop or when it will rise on a daily basis. The only thing that we can say is that over time, the market will rise. Look at any stock market chart for proof.
Yes, there are drops (or bumps) along the way, but the long-term trend is positive.
For example, look back to the Great Recession. Many investors fled the market and sat on the sidelines for years, too scared of the stock market.
But if you had actually stayed invested, you would have seen your money grow to more than what you hadbefore the Great Recession. I can attest to this. I have much more than I did before the Great Recession.
In fact, during this time I worked for a financial planner and we kept most of our clients in the market during this entire crisis. Most of them earned back what they lost by late 2011. You have to stay invested if you want to see meaningful returns.
The start of 2016 is the same thing. In 10 years, most likely the stock market will be higher than it is today. If you pull out of the market and sit waiting, you are only hurting yourself. This is some short-term pain, but the over the long-term, you will be rewarded for staying invested.
If you are still scared of the stock market, then your best option is to look into hiring a financial planner. Yes, they cost money, but the expense is well worth it. They will help to put you into a portfolio that matches your risk tolerance and they will be a rational hand to hold onto when the market drops.
When you get scared and want to sell, they will be the voice of reason for you. They will help to keep you invested over the long-term so you can benefit from investing in the stock market.
Investing On Your Own When Scared of The Stock Market
If you are scared to invest in the stock market and you don’t want to pay for an advisor to hold your hand, what can you do? I have two options for. First, I’ve created the following approach for you to follow.
When you first start out, invest the majority of your money in bonds. I would suggest a mix of 80% bonds and 20% stocks. As you begin investing, you will start to see how the market works. You will realize that the media hypes both the good times and the bad times. You will need to learn to tune these out.
Additionally, you will need to learn about investing. I am not saying you need to get your MBA or get a second degree in finance. Rather, learn the basics of investing. There are some great books that are very easy to read. Two that I highly recommend are:
- The Intelligent Investor, by Benjamin Graham
- A Random Walk Down Wall Street, by Burton Malkiel
As you learn more about the markets, you will become more comfortable with how it works. Each year after you start investing, you should change your allocation 5-10%, lowering your bond allocation and increasing your stock allocation by investing more money into stocks. (Note that when I say “stocks” I am talking more about mutual funds than individual stocks.) You can see what I suggest in the box below.
Eventually, you will get to and keep your allocation somewhere between 60-80% for stocks and 20-40% for bonds. This mix will allow you to earn a return so that you will have enough for retirement (assuming you save) while keeping an eye on risk.
One note about this process, be sure to really gauge your comfort level as you raise your stock allocation. I suggest you raise it each year, but that is just a suggestion. If it takes you an extra year to go from 40% stocks to 50% stocks, that is OK. At the end of the day, you have to do what is most comfortable for you.
But with that said, you really do want to get to at least 60% stocks and 40% bonds. This portfolio will give you the growth your savings needs and still protect it when the market drops.
Some readers may question my logic here and say that you are giving up years at the start when you should be 100% in stocks (or at least have a high percentage of your savings in stocks). While I agree that most investors should start out with a large percentage in stocks, some people are risk adverse, meaning they don’t like the risk.
This plan allows them to get comfortable with investing and still grow their portfolio. Much of the fear comes from a lack of understanding. Once you learn more about how the market operates, you will become more comfortable with it and be willing to take on more risk through a calculated approach.
Also, when you first start out investing, you have very little money. Delaying the growth of a few thousand dollars for three years won’t be the deciding factor if you can afford to retire or not.
Using the return of the S&P 500 Index and the Barclays Bond Index for the past 40 years shows the 100% stock portfolio would be worth just over $1.1 million (assuming a $5,000 annual investment for 40 years). A portfolio of 40% stocks, 60% bonds for three years, then switching to a 60% stock, 40% bond allocation would be worth about $1 million, a difference of $150,000.
In all, the “cost” of $150,000 for the peace of mind of knowing you will be able to afford to retire is well worth it.
The second option is to look at a robo-advisor. Personally, I use and recommend Betterment. They have you go through the steps above in terms of picking a portfolio based on your risk tolerance and goals. But they automate everything else. This helps to take your emotion (specifically your fear) out of investing. You can essentially “set it and forget it”.
Each month, an amount you had chosen when you opened your account will get transferred to your Betterment account and invested. You don’t have to do anything else. You can learn more and sign up through this link.
At the end of the day, you need to overcome your fear of investing in the stock market. You start this off by understanding the reason or reasons why you are scared and then put this fear into perspective. From there, you have to educate yourself about the stock market and investing in general.
Realize that corrections and volatility are what happens in the stock market. It is part of the process. The stock market will never simply rise all of the time. It has to pull back and drop now and then. The key is to make sure you are prepared for this by creating an investment plan and portfolio for your needs and goals. When you do this, any drops in the market will be easier to stomach.
From there, keeping things in perspective goes a long way in not acting on emotions and sticking it out for the long term, which is your best move financially. If you find yourself getting upset when the market drops, hopefully the following analogy will help you.
Picture a boat going past as you are on a raft in the water. Directly after it passes, the waves are huge and you get knocked around on your raft. But as you follow the wake of the boat further back, you see the waves become smaller and smaller and your ride becomes much smoother. This is stock market volatility. In the short term, the waves are big and scary and the ride is rough. But as you ride it out, the waters calm down and the ride is easier to handle.
Remember,you can’t control the volatility of the stock market. Do your best to ignore the doom and gloom on the news and stay the course. You don’t know what will happen tomorrow. The market could be up big tomorrow. We just don’t know. So sit back, stay invested and focus on the long-term. It’s the key to building wealth in the stock market.