By Ben Carlson, A Wealth of Common Sense
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
I recently came across an old Peter Lynch interview for Frontline on PBS from the mid-1990s. In it the legendary former mutual fund manager discusses a wide range of topics from how he got started in the investment business to the crash of 1987 to the psychology of average investors.
Lynch’s thoughts on losses in the stock market are still relevant today:
Now no one seems to know when they are gonna happen. At least if they know about ‘em, they’re not telling anybody about ‘em. I don’t remember anybody predicting the market right more than once, and they predict a lot. So they’re gonna happen. If you’re in the market, you have to know there’s going to be declines. And they’re going to cap and every couple of years you’re going to get a 10 percent correction. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline.
They’re gonna happen. When they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years?
What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market.
The most important point here is that no one knows when or why corrections happen. Investors are continually searching for reasons for stocks to fall. It almost becomes a game for some to say that the can predict the exact event that does it.
There’s always something to fear that will possibly derail the market — profit margins, valuations, earnings shortfalls, economic growth, rising/falling interest rates, inflation/deflation, geopolitical risks and the list could go on forever.
The problem is sometimes stocks rise and fall for no apparent reason whatsoever. Occasionally these issues “matter” but other times the market simply shrugs them off.
This past Thursday’s 2% loss in the S&P 500 is a case in point. The headline writers tried to come up with the news of the day to explain why the market fell, but there wasn’t much there. It’s not always a neat and tidy explanation except for the fact that there are times when there’s more selling pressure than buying pressure.
Investors need to concern themselves with the fact that stocks do go down occasionally. Trying to continually predict the spark that sets it off can lead to more harm than good. Seth Godin had a good take on the idea that bracing for impact too often can be to your detriment:
Worse than this, far worse, is that we brace for impact way more often than impact actually occurs.[...] All the clenching and imagining and playacting and anxiety—our culture has fooled us into thinking that this is a good thing, that it’s a form of preparation.
It’s not. It’s merely experiencing failure in advance, failure that rarely happens.
When you walk around braced for impact, you’re dramatically decreasing your chances. Your chances to avoid the outcome you fear, your chances to make a difference, and your chances to breathe and connect.
Understanding stocks can and will fall is helpful to prepare yourself mentally for how you’ll react once they do. But bracing for impact at all times can be counterproductive to a good process.
See my latest for Yahoo Finance on how 2% daily drops in the market aren’t as rare as most think (Yahoo Finance)