Investors in a Market Meltdown

The global economy is sluggish. Falling consumer demand is dragging down commodity prices, which has hit energy companies and emerging countries especially hard. A slowdown in China’s expansion has led to a severe correction in its stock market, which is now spreading to other markets around the world.

It’s human nature to get emotional about your money when you hear about a market meltdown and see your account balances shrinking. But one way to counter fear is with faith — in this case, faith that things will eventually calm down and that when they do, you’ll be well positioned to succeed. To that end, here are some “commandments” to follow in the midst of market volatility to maintain your sanity and preserve your portfolio for the long run

Thou shall not sell

Some investors panic and sell all or most of their holdings at the first sign of trouble. This simply makes no sense. We expect markets to “correct” and to underperform at times, so we should sit tight and stick to our plan. We invest in stocks to get a return, but that return is highly correlated with volatility. Therefore, if we want higher returns, we must be able to accept the downturns along with the upswings.

The stock market has been overvalued for some time. Unfortunately, no one knows when and how it will ultimately correct. It may come as a large crash or as a prolonged period of lackluster returns. As the economist John Maynard Keynes famously said, “The market can stay irrational longer than you can stay solvent.”

That is why market timing is so difficult. You must be right twice — once when getting out and once again when getting back in. Most people who converted to cash in 2008 did not reinvest in the market until it was well into its recovery. They missed months, if not years, of appreciation

Thou shall not have unrealistic expectations

Market cycles are normal. However, over the past few years, the U.S. stock market appeared immune to a downturn. At the beginning of this year, the S&P 500 Index, a proxy for large company stocks in the U.S., had not experienced a correction of 10% or more in over three years. The higher-than-average returns we experienced in the past five years cannot be extrapolated into the future. It is unrealistic to think the market will deliver double-digit annual returns indefinitely. In fact, because of current valuations, most analysts expect far lower returns of approximately 4% (before inflation) over the next 10 years.

In addition, returns are neither uniform nor constant. There will be swings, both positive and negative, around average returns. The variance can be quite large. Consider this statistic: From 1928 to 2014, the average annualized return for the S&P 500 was 9.6%. Guess how many years the actual return for the year was within 25% of that average — meaning, between 7.2% and 12.0%.