When it comes to investing, one of the principles for success is to avoid letting your emotions creep into your decision-making or behavior. Apart from maintaining a proper perspective about how the stock market has historically behaved, one of the best ways to do this is by proactively engaging in “lifeboat drills.” These involve imagining the next stock market pullback, or bear market, and thinking about how you would feel (or be inclined to react) in light of your situation, your investment temperament, and your goals. Doing this can help you put together a playbook in advance (even if that playbook is ultimately to do nothing), so you aren’t left making reactive decisions in the moment when emotions are involved.
Outline of this episode
- Where we stand today compared to March 2020 [1:34]
- Remind yourself of the realities of investing [7:41]
- Reassess your investment allocation [9:37]
- Have a plan for the next decline [11:24]
- Using today to prepare yourself for what’s to come [13:21]
- The recap [15:42]
Where are we today -vs- March 2020?
The short answer is up. A lot. But to elaborate a little, the theme has been pretty consistent over the past couple of years. Almost everything, at least as it pertains to the stock market, has recovered faster than expected. If you think back to February and March of 2020, the stock market experienced a sharp 35% decline in less than two months as COVID was first emerging.
People were thinking the worst, and there was no visibility or end in sight at the time. Like a rubber band following that sharp pullback, there was an equally sharp recovery that has been going on since late March of 2020. However, it hasn’t necessarily felt like it on a day-to-day or month-to-month basis (especially early on in the recovery) since the headlines were negative and we were still facing many of the same concerns around COVID that caused the decline in the first place.
Preparing your perspective
As we mentioned, the stock market has been up a lot over the past two years, and at the time of this recording the stock market is at or near all-time highs. This was a sharp recovery from the significant pullback in March of 2020 and serves as a reminder of the contrast that can exist between how things feel during a given time period and what the stock market does during that time.
Knowing the stock market is close to all-time highs, whether it's now or at some point in the future, it's helpful to have a proper perspective of how the stock market behaves over time. Remember, the stock market has an average annual peak-to-trough temporary decline of roughly 14% every year, a decline of 20% or more roughly one out of every five years, and a decline of 30% or more one out of every 10 years or so. This isn't about making a prediction, but rather understanding and accepting the realities of investing and having a healthy dose of rational optimism.
In the episode, we touch on the importance of engaging in lifeboat drills when things are "good" with the stock market being up. As part of the lifeboat drills, you want to be proactive with what you should do today and how to help yourself in the moment with a plan of what you will or will not do during the next temporary stock market decline.
And lastly, realize that investing is a journey rather than a destination. Everyone is unique with what life stage they're at with different views on what's most important to them. So the goal is to make intentional decisions of what will help you best navigate investing over multiple decades while being fully aware of the trade-offs of your decision
Resources & People Mentioned
- Podcast episode #5: The 80:20 Rule of Investing
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup