The following post was first published in August 2011 after a nasty 20% drop in the S&P 500 index. That was a pretty rough time for investors. Right now, the market is pushing all time highs. I thought it might be a good idea to refresh our understanding by taking a look at the market correction of 2011 to gain some perspective. At the close of the post, I’ll give you a few takeaways and how to apply those lessons to the situation at hand:
We all witness steep stock market declines at one time or another. Unless you have a crystal ball and know exactly when to step out, this kind of experience can be worrisome. Even if you use a more proactive approach to investing there is no guarantee you’ll be able to mitigate any or all of the potential damage.
Having said that, let’s try to understand what is really going on now and then figure out how to respond appropriately.
Why did the market plunge?
It’s interesting. The economy in the United States is basically in a status quo position. In other words, nothing has really changed from where we were several months ago. We didn’t go into default. The government is still operating and paying its bills. If anything, there has been some positive movement toward debt reduction from both sides of the aisle. Yet we saw a pretty big dive in the major indexes.
Other explanations for the plunge force us to look abroad. The international markets took huge hits because of their own debt struggles. And those problems overseas may have been a large contributor to what we saw happen in our market.
Is it 2008 all over again?
Maybe…but I doubt it. It may feel just as scary, but the reality is that 2008 brought cataclysmic changes that brought down brokerage firms, insurance companies, automobile manufactures, etc. Entire industries were wiped out. Right now, we’re not expecting those kinds of problems. (Obviously, things could always get worse.)
How long will this go on?
Of course, nobody knows the answer to this question. But (believe it or not) I am very optimistic long-term. Lessons we are learning now will be translated into changes in our tax code and government budget (which I believe will happen). When that happens, the business climate will improve. Nobody wants the status quo to continue and again, this is a positive for everyone, regardless of your political beliefs.
Should you put everything into gold?
Every time I turn on the radio, somebody is trying to sell me gold. That frightens me. It feels like a bubble. Many people have made some nice profits but the huge increase in the price of gold could all be speculation. As a result, I’m not a fan of piling into gold at this time. Of course, I could be wrong. We could have run-away inflation and see further spikes in the price of gold, but I just don’t think making a big investment in gold is prudent right now. But you’re an adult. You can decide for yourself.
Takeaways from 2011
First off, if you are keeping a score card, I was right about gold and the market. Gold dropped 30% and the market recovered and then some. But I was wrong about the government – nothing seems to have changed much in D.C. Sorry about that.
But this really isn’t about my predictive powers – I don’t have any. This is about context. I’m sure you remember what happened to the market in 2008 but chances are good you forgot completely about the 20% drop in 2011.
When you are going through a particular situation in the market, it feels like it will never end. Then, when the situation shifts, people find it hard to believe. When times are bad, people think those bad times will never end so many move to cash and stay there or invest far too conservatively. When times are good, they sometimes become too aggressive and end up paying a huge price.
Times are good now – but please don’t let that impact your overall strategy. Think about your long-term goals and how much risk you are willing to take on – in good times and in bad. Then, invest accordingly. If you change your investment approach based on how the market is doing at any given time, you are asking for trouble.
Of course I am not suggesting that you buy and hold and forget about your money. I don’t think that’s a good approach at all. But however you invest make sure you are clear on your rules (when to buy, what to buy and when to sell). Whatever your rules are, be crystal clear on what they are and why they are your rules. Once you have your game plan, don’t change it just because one or two plays go against you.
Has the recent bull market impacted your investment style? How?