Panic on the streets of London
Panic, The Smiths
Panic on the streets of Birmingham
I wonder to myself
Could life ever be sane again?
Avoid debt. Live below your means. Invest the difference in the stock market. Let compound interest work its magic over time and make you wealthy. Sounds easy, doesn’t it? Except you’ve invested money you earned from the job you probably don’t like very much, money you could have spent on something fun, and now you’re watching it evaporate into thin air before your eyes as the market drops.
The modern equivalent of Panic (the song was released in 1986) might be “Panic on Social Media”, which admittedly isn’t likely to sell many records. Any time there’s a stock market drop of more than around 10%, people flood social media asking the same basic question: should I sell my investments before they drop further, or should I hold on? The harder and faster the drop, the more panic.
What should you do if you’re panicking and thinking about pulling the trigger and selling?
Before We Dig In: An Important Caveat
I’ve assumed that you’re happy with your investment choice but you’re panicking because the value is dropping. For example, you’re invested in a well-diversified index tracker like the FTSE Global All Cap rather than having all your money in a single company. This is a critical assumption and distinction because a well-diversified index fund will ride out the bad times, whereas any single company, no matter how big, has the potential to go bust (think Enron).
Your Outcome is More Important Than Your Feelings
One of the most important points I want to get across is that what you want in the long term is more important than what you feel in the short term.
By the long-term, I’m talking about 5, 10, 15, or 20+ years down the road. You want your investments to have grown over that timeframe. The longer you stay invested, the more likely that is to happen – to the point that after 20 years, the chances of you losing money in an index fund are virtually zero. But the ride along the way won’t be a smooth one; it will likely consist of periods of steady growth followed by short, sharp drops.
When you’re panicking and feeling fear that you’ll lose your money, you lose sight of that long-term goal. You think of the here and now, where you see your hard-earned money disappearing, and you want to prevent that loss from getting worse; you want to stem the bleeding. Humans tend to feel losses more than the equivalent gain; this is known as loss aversion.
Take a step back, breathe, and remember why you invested your hard-earned money in the first place: you want it to grow over time, you want to buy back your time, you want to achieve financial independence – whatever your particular goal is. A temporary drop in valuation has not changed those goals nor invalidated your plan.
Thoughts, Feelings, Behaviour
Your thoughts affect your feelings, and your feelings affect your behaviour.
If you’re feeling angry that your money is disappearing, you’re more likely to make a reckless decision, like selling.
If you’re feeling anxious or fearful that you’re going to lose all your money, you may also be tempted to sell.
Decisions made in anger or out of fear are almost never good ones. Do something that calms you down, like going for a walk or listening to this meditation from JL Collins:
Focus On What You Can Control and Let Go of the Rest
You can’t control what the stock market does. You can’t control whether valuations rise or fall. You can’t predict the future.
What can you control? Your thoughts. Your actions. Your behaviour. Will you sell or hold? That’s within your control.
Don’t Confuse Volatility with Risk
Risk is the possibility that something bad will happen – in the case of the stock market, that you’ll lose money. But if you don’t sell your shares, you don’t realise any losses – you have the same number of units, they’re just worth less than they were. In time, they’ll be worth more again.
Volatility is how much the valuation varies. When you buy the same products at the supermarket every week, they’re generally consistent. Your pack of cornflakes doesn’t go from £1 to 50p to £1.50 to 90p on a week-by-week basis. The volatility of the price is low. In the stock market, it’s possible that the valuation of your shares drops by 20%, 30%, or even 50% in a short period of time. This is to be expected. It’s normal behaviour.
Reward Comes with Risk
If you could get 7-10% returns in a cash ISA or savings account with zero risk, we’d all be doing that. You don’t – you get peanuts. Worse, you get the purchasing power of your money eroded through inflation. To get the returns that beat inflation we have to handle some risk. The longer our timeframe when looking at the market, the lower our risk – until it becomes virtually zero if we’re patient enough.
If You Sell Now, You’re Selling at the Worst Possible Time
If your shares drop by 30% and you sell, you’re realising that loss; you’re making it real. When it bounces back, as it inevitably will, you’ll then be investing at a higher price. How will you know when to get back in the market? Repeating this pattern of selling low and buying high is the fast path to losing money. JL Collins, in his great book The Simple Path to Wealth, has this to say:
Everybody makes money when the market is rising. But what determines whether it will make you wealthy or leave you bleeding on the side of the road is what you do during the times it is collapsing.
JL Collins
