Vanishing Options, Overreactions, and other Stock Market Observations

stock volatilityStocks go up, and then they go down. Or vice versa. Markets generally trend upward over time, but there is definitely volatility over time. We know that this happens, based on historical data.

It is what it is, and things should be simple to understand, right?

Well, the recent volatility in the markets here in the U.S. have garnered some attention in the news lately. After surging forward for much of the year, aside from a few pullbacks here and there, the market had some down days last week. It’s almost as if a game of musical chairs was being played, and the music suddenly stopped. The bull market party was seemingly over – or, at least on hiatus until yet another one-day rally.

What kind of reaction does that cause with people? Well, I think that it depends on who you’re talking to.

Vanishing Options

I was talking to a friend of mine last week, and he’s generally a very financially savvy person. As in, doing very well with his career as well as saving a high percentage of his income and investing it wisely. He’s also smart when it comes to identifying risks. In short, he’s typically someone who is good at thinking about the key personal finance questions that I wrote about previously. Frankly, I have to admit that he’s done better than me in this regard.

However, in this case he had a different take on the market downturn. He was commenting that they had a good number of stock options that ended up losing a ton of value during that week. This was a particular problem because they had apparently earmarked that money for some major updating to their home. Now, this would have to come out of savings. I believe some money had already been spent.

I don’t think he was the main driver behind spending this money; actually, I think it was his wife. Regardless, the excitement over having such funds – on paper – could have driven some of the decision-making in terms of those expenses. Again, that’s just money on paper.

While that may be frustrating, it probably speaks to the bigger point that we should know that markets go up and they also go down. What goes up will ultimately come back down somewhat, at least to a certain level.

So, it’s smart to not get carried away in excitement over big gains!

Panic Selling

I know another person who talked about pulling out of the market entirely. Instead of getting overexcited, he is highly defensive in his orientation toward money. Not defensive in conversational tone, or anything like that. Just very risk-averse.

Now, if someone is closer to retirement age, it makes sense to be more risk-averse. However, being further away from retirement than that, this guy has a ways to go before reaching the finish line. So while capital preservation is important, people in this age range need to count on some growth.

Here’s the thing: it seems like the market’s overall orientation is upward over the long run. True, right? Plus, there are examples of market overreactions to bad events as well.

One example is the sharp stock market decline after the U.S. credit rating downgrade a few years back. Sure enough, stocks more than recovered not long after that. Another example is how Japanese stocks plummeted after the devastating tsunami earlier this decade.  Within weeks, they came back to prior levels at the market level.

In either case, panic selling didn’t accomplish anything over the long run. What goes down, ultimately comes back up – at least in terms of overall markets, that is.

So, it’s not smart to completely panic over market downturns!

Bottom line: Ups and downs happen, in markets and in life. Sometimes it’s how we actually handle the changes, rather than the changes themselves, that can determine our success.

My Questions for You

Have you seen people overreact to market ups and downs?

How do you handle long-term bull markets, or even sudden downturns in the market?