Maintaining Discipline During Market Downturns

Markets move according to one simple rule —what goes up must come down and what goes down must come up. This is how markets achieve balance or equilibrium. Lots of people don't understand this rule.

This year, the markets have been on the roll. Both S&P 500 and Dow Jones indices have broken the previous high's from 2007. So, a few news events very recently sent jitters to the markets erasing gains from the last two months in just a week. That was a very quick sell offs.

While this is perceived as a bad news by many investors, I believe that such downturns present great opportunities for patient investors. This is an opportunity to keep buying stocks (or mutual funds) at discounts.

But, our genetic programming prevents us from doing so. When losses occur, they look more magnified and trigger emotions related to our survival.

During our species' evolution, these emotions were needed to help us conserve our precious resources and defend them from losses. But, these "survival" emotions have very little use today because our evolutionary survival is not generally at stake and certainly not true for stock market investors.

When markets go down, according to the survival instincts, many investors feel they have to do something during a market downturn. But, such emotional reactions prove counterproductive in the longer run. Reacting to short-term market events by making dramatic portfolio changes makes it difficult to stay on course to achieve your investment goals.

History shows that the disciplined investors will often be the ones rewarded when markets return to their upward path. Major declines have generally been followed by major recoveries.

Here are examples from the recent past.

In 1974 (oil embargo), the S&P 500 index was down by 25%, but the following year returned 18%, and next 5 years returned an average of 22.3%.

In 1981 (inflation), the S&P 500 index was down by 10.2%, but the following year returned 5.5%, and next 5 years returned an average of 13.8%.

In 1990 (gulf war), the S&P 500 index was down by 14.8%, but the following year returned 12%, and next 5 years returned an average of 10.8%.

In 2002 (dot com bust), the S&P 500 index was down by 12.4%, but the following year returned 26.7%, and next 5 years returned an average of 18.3%.

In 2008 (financial crisis), the S&P 500 index was down by 33%, but the following year returned 35.1%, and next 5 years will probably return double digit averages.

Fact is, no one can precisely forecast market tops and bottoms. Those "gurus" who claim to predict markets are only playing to our "survival emotions". It is extremely risky to react based on market predictions or after the fact for two reasons.

Selling an investment during market declines does nothing but only guarantees a loss that otherwise only existed on paper.

Once you are out of the market, timing to get back in hard as no one can predict if the bottom has arrived and the market is on the upswing.

This is why I believe in long-term disciplined investing. If you stay disciplined during both good and bad times, markets will eventually average out your your steep losses (as well as extraordinary gains). Hence, I invest primarily in index funds and do not try to time the markets. I am happy with average returns because it is slow but steady path.