Rational Thinking in an Irrational Market

January 24, 2008 – 3:32 pm

On January 23, 2008, the major US stock market indexes plummeted almost 3% in early trading. They stayed around that level for the majority of the day, until roughly an hour before closing, when the tide turned. It was like MC Hammer right after signing a new record deal; people were buying anything they could get their hands on. The S&P 500 index closed up 2.5%, meaning it managed over a five percent swing in about an hour. How can the average investor handle such massive swings?

Retirement Saving is a Marathon

The average investor is chiefly concerned with their nest egg: the savings they plan on keeping until retirement. After all, unless you are an arbitrage artist who flips stocks for a living, you’re only worried about after you kiss the nine-to-fivers goodbye. Once you get your retirement savings path squared away, you are good to go.

For this reason, especially if you are young (or *cough* young-er), daily market fluctuations are inconsequential to your goal. With this mindset, the only thing that matters is how your money grows between the time you invest it and your retirement. So, if you are retiring tomorrow…maybe you are a little concerned about how the market did today. Otherwise, a rational mindset should ease your concerns about day-to-day market swings.

Change Your Outlook

Most people are instantly worried when they see the days trading resulted in a loss. It probably has to do with the subliminal messages sent by massive red down arrows next to indexes and dooms-day headlines like Recession 2008: How Bad it Can Get.

Think of it this way. You’d rather acquire a stock when it is cheap, right? When the averages are down, it means that, generally, stock prices dropped. It’s like an impromptu everything-must-go sale! All the stuff you were looking at yesterday is cheaper today. Now, if all signs point to a continued decrease, maybe you don’t pull the trigger just yet. The point here is to look at an index drop as an opportunity to buy cheap instead of the end of the world.

Develop a Plan and Stick to It

The underlying principle in this discussion is this: for any type of investing, develop a plan and stick to it. Assuming your plan is based on solid financial principles, eventually your choices will pay off. What hurts so many investors today is panicking as the first sign of trouble and abandoning their strategy to achieve their long-term goals. All you are doing is adding to the pandemonium.

Now, creating a fool-proof plan is no trivial task. Seek a professional opinion or that of one who has a passion for finance. Maybe your geeky index-loving nephew who runs all kinds of Monte-Carlo simulations in his parents basement has a use after all. Tell them what you hope to accomplish, what resources you have available, and the time you have until retirement. With this information, you can decide where best to stash your money so retirement will be full of tee times and cruises instead of penny-pinching and hoping a Social Security check will still exist* to bail you out.

So the next time the market drops a couple hundred basis points, sit back, relax, and crack open a Corona. You’re the tortoise, not the hare.

* Note: It won’t.

Tags: investing, personal finance, retirement, stock market