Unless you’ve been living under a rock the last couple of months, you’ve probably noticed that the stock market is down for the year. At the time of writing, the S&P 500 was off 2.66% and the Dow was down 3.29%.
This can make any investor nervous, especially if your the kind of investor (like me) that funds your lifestyle from investments.
So how do investors get comfortable with negative returns and stay calm during volatile markets?
Yes, Markets Fluctuate
Let’s do a little reality check here: It’s been 9 years since U.S. markets last saw a negative year. Yes, 9 years! We last saw a negative return year for the S&P 500 waaay back in 2008.
These long periods of positive returns are actually unusual market behavior, and far from “normal”. In fact, the last time U.S. markets saw a boom of this magnitude was in the 1990’s (1991-1999). This was the largely the dot-Com boom which brought about the internet and e-commerce for the masses. It changed the world.
That boom was subsequently followed by three years of negative returns.
Yep, negative years do happen.
If you ever plan on living off your investments (now or later), you need to get comfortable with this fact. Negative years (sometimes multiple negative years in a row) are a normal part of market behavior.
Look At The Forest, Not The Trees
But being comfortable with “losing money” isn’t easy. Even experience investors can get “itchy fingers” when they see the market falling day-after-day.
So here’s the first thing to remember: Today’s current market price has very little to do with your long term returns.
For most stocks, only a tiny fraction (usually significantly less than 1%) of a company’s stock trades on any given day. Why should such a small subset of shares trading hands worry you?
It’s just like if someone sold a house at an unusually low price in your city. That sale price has very little to do with what YOUR house is worth.
You wouldn’t decided to sell your house because another home-owner got themselves into financial trouble, would you?
The long-term picture is far more important!
Dividends Dividends, Dividends!
I’ve been pounding this drum for years now, but instead of watching market prices, investors should be focused on real business returns, not the crazy manic behavior of Mr. Market.
For most investors, real business returns appear as dividends. That’s right — good old fashion dividends. A check that comes out of the company’s bank account every quarter and gets deposited in yours.
THAT is a real return! If you make good investments, these dividends continue to grow year-after-year because of compounding. It can happen during recessions and booms too!
According to research done by professor Jeremy Siegel in his book “The Future For Investors“, dividends have historically made up about 50% of stock returns in US markets. That’s pretty HUGE when you think about it.
So don’t worry if the market becomes volatile or negative for the year — Just check on your dividends and dividend growth rates! Those are two numbers are an easy metric to track!
Everything good? Keep calm and dividend on!
Read The Annual Report
But what if your investment doesn’t pay dividends? Some companies choose to reinvest all profits back into the business… and that’s totally OK. This can often lead to very fast-growing companies, but very volatile stock prices.
Fast growers like Tesla and Netflix can experience huge swings (plus or minus 20%) in any given week.
So how do investors stay calm when they don’t have the safety of a steady dividend assuring them a stable business exists behind those shares?
Cover your eyes and start praying….
No wait, wait, that’s not right! Stop looking at the market price, and start tracking your investment performance using non-market based metrics. You’ll have to crack open an annual report (or quarterly report) to do this.
Companies publish financial reports regularly, and reviewing the financial state of your investment goes a long way toward calming investor fears.
Some companies that don’t pay dividends use change in book value per share to show non-market based returns to investors. Berkshire Hathaway (for example) has been doing this for decades. It’s usually on the first page of his annual Letter To Shareholders.
This is a fairly good way to go about it (but not perfect). As long as that book value keeps marching forward at a steady clip, investors can be assured that market prices will rise again.
Other businesses toute unusual metrics like “number of subscribers”, or “gallons of product produced” — but equating these back to reasonable stock prices can be quite tricky. Choose your metrics carefully.
Using non-market based metrics is an important part of keeping your cool during down markets, but this works best when you hold individual companies. When you invest in hundreds of companies via a index, this becomes is rather unrealistic.
Do Something Else
The thing is — markets are always changing their mind. One day a news article will come out that will have investors freaked out and selling shares. The following day will have another news article telling investors “it’s all OK!”
Really, who knows what the future holds? One day might be a giant negative trading day, and the next day might be a super positive trading day based on no news at all! Sometimes the changes are tiny, and sometimes they’re big violent swings!
You can’t make yourself sick over what Mr. Market is doing! Just get your mind off the market!
This is why I strongly recommend the following action next time Mr. Market is in a fowl mood — take a deep breath and go do something else!
Ignore the news about trade wars, NAFTA re-negotiations, or pending recessions. Go for a walk and get some exercise instead! Or, work on a personal project. Volunteer in your community. Find something (anything) to do that isn’t staring at red numbers and worrying over what might happen.
Business is not going to dry up tomorrow — There will be more people in the world tomorrow, and those people will need food, shelter, clothing, healthcare, entertainment, and a vast number of different services to make life easier! As long as people have needs that must be filled, businesses will work to fill those needs… and ultimately profit from them.
I have absolutely no idea if the next 5 years are going to be negative years or positive years, but I’m confident that my investments will be worth more in 20 years than they are today.
Why am I so confident?
Real long-term returns are all about compounding. As long as I can watch that compounding at work, year-after-year, I know the true intrinsic value of my investments will continue to rise.
Here’s one of my favorite quotes from Buffett that makes this point perfectly:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
It’s in the compounding where the weight of an investment hides. So wrap your tentacles around compounding in all its wonderful forms.