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In the previous Part 3 of Hitchhiker’s series we talked about how our mind is ‘moving’ during a market correction. This edition gives you an insight into what is actually going on when markets drop.

Knowledge is power but the truth is just liberating…

I’m not a fan of boring tables and graphs, but I want you to have a look at the picture below because I want you to start learning objectively and intellectually all about the bear markets.

 

Hitchhiker Guide To Investing Michal Bodi Part 4

These are the historical facts and if you know the truth, you can’t get surprised.

Because once you realise that the market corrections are organic and simply assume that they they’re always coming…you’re in a better position to process them. You’ll also realise that although they’re all different in the detail, they’re all the same when you pull back and look at the whole curve.

You’ll also see that every correction is followed by a bull market and that it’s just a matter of time until the markets eventually recover.

This time [enter the date of the apocalypse du jour] is not different…

The next thing I want you to know is quite extraordinary.

A $1,000 invested in the ASX index as recently as in January 1945 (the end of WWII and the birth of first baby boomers), is worth over $2M today. (If you left it alone, if you let the dividends compound and if there was any tax payable you paid it from another source).

Can I please ask you to pause for a moment, take a deep breath … and try to process the idea that mainstreams equities in this country, if you left them alone, didn’t speculate and let them compound, have since 1945 multiplied over 2,000 times.

That’s such an incretion of wealth for which there is no comparison in the human history!

The next thing I want you to realise is that while the market was so brainlessly and effortlessly compounding equities over 2,000 times, it went down an average of 35% thirteen times! And I assure you that every single one of these thirteen events was reported to people (day by day, minute by minute) as the end of the world.

What does it mean in practical terms? In order to experience the amazing compounding effect of the market, all you’d have had to do over the sixty years or so was to sit through thirteen ends of the world when at least a third of your portfolio literally (temporarily) disappeared. And I don’t need to tell you that many have given up.

So, what can we do to cope with this … the market completely randomly just starts decreasing in value…what should we do!?

Hey here’s something we can do about it – we can get out at the top of the market and come back when it bottoms, right?

Wrong, we can’t (although it doesn’t stop many to tell you they can)!!! We don’t know when the first is coming and we don’t know when the second is coming. And by the way that’s the problem with the market timing; you have to be right twice – know when to exit and know when to come back in. Regardless what anyone tells you, no one can consistently do that. It’s not hard to do… it’s impossible to do on the consistent basis.

That only leaves us with one option – (by the way, when I find the better way, I’ll be the first one to let you know) – in order to capture all the tops we have to sit through all the bottoms. It’s that simple – patiently simply sit and wait things out.

Simple doesnt mean easy

SIMPLE DOESN’T MEAN EASY

That’s where the problem lies – it’s not an intellectual decision we have to make. It’s an emotional (behavioural) decision. And you probably won’t be able to make it on your own. That’s why I’m making such a big deal about it. This is the mother of all behavioural issues when it comes to investing – what do you do when they go down…!? The only answer to that is nothing, just sit there. That’s the sum of it. Hold. As painful it is and as difficult it is, it’s the only way.

As mentioned in Part 3 of Hitchhiker’s series sitting and waiting is going to be the hardest thing (and close to impossible) if you don’t know what’s going on and you don’t know the truth.

Here are four more things that you just need to know in order to process the corrections the right way:

1. Market corrections are organic – they’re part of the process. The market goes up permanently and every now and then (randomly but temporarily) it drops. It doesn’t mean that the investment cycle or the interest rates cycle or the business cycle has been repealed. They haven’t, this time is not different .It’s a normal occurrence.

There are no good or bad markets, there’s only the market – the process of permanent advance, punctuated from time to time, by significant but temporary declines.

  1. Price and value are inversely related – when a price of something is increasing, its value is in fact decreasing and vice versa. Speculators tend to equate the price and value, they don’t know that if the price goes up, the value goes down and it’s the risk that goes up. We’re not speculators, we’re investors.

3. The market volatility (the ups and downs) is absolutely necessary – it’s the very reason why equities are able to produce premium returns. Wishing for the volatility to disappear, is the same as wishing for smooth cash returns of 3-5% on average.

The volatility = the premium returns.

4. The bear markets are when real investors make their real money – sums up all the previous information. If you keep investing new money in or a regular basis, you are a buyer. As a buyer, you want the prices to be as low as possible so you get as much value for your money as possible. This only happens during market corrections.

 

I really hope this has helped you understand the market corrections, and start seeing them in a different light from now. I also hope you realised that even though the investing is fundamentally simple, it’s incredibly hard due to all the emotions that come with it. And that is the very reason why we all need the third party, objective guidance.

If this is the only article you read, I encourage you to check out the entire Hitchhiker’s series starting from the Part 1.

I’ll be delighted to receive any feedback from you, feel free to connect with me on LinkedIn, follow me on Twitter or send me an email to mbodi@sydneyfinancialplanning.com.au.

 

Images courtesy of AMP Capital and jscreationzs / freedigitalphotos.net

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