Keeping your cool — and taking action — during market corrections

Investing is hard, but not from a technical or fundamental standpoint. Most individuals, if interested, can figure out how to build a discounted cash-flow model or learn about the economic projections that drive a global marketplace. No, investing is hard because it is emotional. It is really emotional at times. And, it is really emotional right now.

The collective stock market peaked on Oct. 3 and has been under severe selling pressure. Why? Market pundits will cite an escalating trade war with China, a budget impasse between Italy and the European Union, failed negotiations around Brexit, rising interest rates and the recent, highly contested mid-term election. But the market knew all of that before Oct. 3.

The trade war with China has been escalating for the past several months. Italy and the European Union have been battling since early summer. Brexit has been an ongoing issue for more than two years. The Federal Reserve has been hiking the federal funds rate since December 2015 while being the most “transparent” Fed in history. Mid-terms occur every four years like clockwork. So, why now?

The answer could be anyone’s guess. We can’t control what the market is going to react to and when. Most importantly, we can’t control the temperament (emotional state) of other investors. To remain rational while others are “losing their heads” requires an understanding of your specific goals and objectives.

For new and younger investors — millennial investors, for example — a market correction is a gift. Buying stocks at lower valuations, higher dividend yields and decades of future compounding is the secret to wealth creation. Prospective purchasers of stocks should much prefer sinking prices.

For anyone who is a “net-saver” — those who make more than they spend in a given year — a pullback in stocks isn’t going to impact their current lifestyle since they don’t expect to need those savings until well into the future.

While it is largely counterintuitive to hope for a market pullback, it is a great way to reframe your mindset to be able to act during volatile markets. While everyone would love an orderly market that slowly and steadily marches higher, that will never happen. There are too many factors and emotions to consider. However, the investor that can emotionally detach from the whims of the market and view short-term corrections as an opportunity to buy their favorite investments at lower prices, will be substantially better off — both financially and mentally.

For those closer to retirement, it can be helpful to think about your investments in different buckets. One bucket should fund your current lifestyle for the next couple of years and should primarily be comprised of cash and short-term investments. While still meager, rising short-term interest rates are finally protecting this pool against inflation and offering some yield to reward savers.

The other bucket for those nearing retirement should have a longer-term view and include stocks. A longer time horizon cushions against the near-term emotional fluctuations of the market, and while every investment decision and portfolio should take into consideration the unique circumstances of that investor, stocks have been the greatest creator of financial wealth in human history.

Owning stocks is not for the faint of heart, however, as evidenced by this recent bout of volatility. In order to minimize the emotional toll on your well-being, change your mental approach. At CapWealth, we own pieces of businesses, not stocks. We know as much about our portfolio holdings as possible to avoid being “emotionally scared” out of them when markets correct.

Fifty years ago, the average stock was held for 14 years – today it is disposed of after 11 months. Short-termism creates irrational buying and selling for everything to do with the near-term direction of stocks, but nothing to do with the long-term value of businesses. As Benjamin Graham said, “Mr. Market can be our servant or our master.” Since the goal of all investors is to be our “own” boss in retirement, let’s continue to choose the former.

 Controlling your emotions is key to long-term financial success. The best recipe for controlling your emotions is to have a financial plan that you understand. John Lueken is the executive vice president and chief investment strategist at CapWealth.