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As expected, the sudden drop in both the Canadian & American stock market has caused investors to scramble to find answers to the following questions:

  1. What is causing the market drop?
  2. Is this a correction or the beginning of a prolonged bear market?
  3. Is my retirement secure?
  4. Should I alter my strategy and sell all my investments?

Fear is clearly on the rise and although these questions are simple and straight forward, there are a few reasons why I don’t think they are the best ones investors should be asking:

  • I’m not sure anyone could honestly answer questions 1 & 2. If they could, I doubt they would have time to write market commentary blogs, as they would be too busy making billions of dollars timing the worlds markets.
  • Questions 3 & 4 are better than the first two because they are concerned about strategy vs. market prognosticating, but the best time to ask these questions isn’t while the market is dropping. Instead, investors should be thinking about strategy for the long term.
  • These questions reveal a lot about the mindset of the person asking them: and that mindset is clearly reactionary and in a state of panic.
  • These questions also reveal a deeper truth about how many investors seem to focus on the things they can’t control (markets) rather than focus on the things they can control (investor best practices).

I’d like to help investors cut through all this panic, and show them what I feel is a better way to think about market corrections and investing.

There is an old saying, “corrections are healthy for the market”. This phrase is often touted as a powerful piece of wisdom coded into the fabric of the universe. I think this phrase represents everything that this wrong with how many investors think about markets and investing. Let’s break down this phrase: it claims that corrections are healthy, but what it is really saying is that from time to time the market is wrong about valuation, and a sudden change in prices, brings the market back to a more reasonable “correct” valuation. This is a terrible way to think of health. Here is a simple analogy to illustrate my point: eating junk food until you get so sick you aren’t able to eat anymore, and then calling that healthy. When it comes to food, we all understand that that junk food isn’t healthy, and true healthy behaviour would be to not eat it in the first place. Health isn’t about having visceral reactions to bad habits, but rather, health is more about having good habits that make your stronger over time. There is, however, one piece of wisdom that I feel most investors are missing here: A correction is usually defined as the market moving opposite to its prevailing trend by more than 10%. And statistically, these corrections happen about once per year. So, it is fair to say that when it comes to valuation, most of the time, the market is wrong.

Before we talk about strategy, let’s bring some perspective to the last few days of market action. Everyone saw the headlines that Friday February 2 had the 6th largest point drop in the Dow Jones Industrial Average in history. What this headline failed to mention is that this day didn’t even make the top 500th for single day declines when measured in percentage terms. As we know, the news tends to sensationalize everything, and this is exacerbated by the fact that for the last 5-6 years investors have become accustomed to low-volatility.

Let’s summarize some of the key points we’ve discussed so far:

  • The statistical frequency of market corrections means that there is always the potential that the market is mispriced at any point in time.
  • Some investors are focusing more on markets and less on long-term strategy.
  • The last week’s market action is far from sensational, historically speaking.

With all this in mind, I’d like to give investors some other questions that I think are better to focus on.

  1. Is my strategy appropriate for my time horizon?
    This question goes right to the heart of what is panicking many investors: reconciling the unknown future value of the market, with the known future liability of retirement (or some other investment objective). When it comes to markets, it is impossible to predict what will happen in the short-term future, but it is easy to analyze what has already happened in the past. And although, many investors look to the past for guidance, they are often looking in the wrong places by focusing on potential future return, when they should be focusing on potential future risk. Investors should try to understand the many different types of risks and how they impact different assets over different time horizons. Nothing can guarantee success, but this the best way to ensure you are using the best strategy to complement your time horizon.

  2. What things can be done to enhance my chances of success?
    This comes back to the idea of focusing on what is controllable vs. what isn’t controllable. If an investor’s strategy is already well matched to their time horizon, then their own behaviours might have a greater impact on their success than the markets. Investors can enhance their chances of success by focusing on things they have control over:
  • Contributing more to their strategy than they initially planned.
  • Having a large enough emergency fund that is separate from their investment funds.
  • Using insurance to protect against certain types of risks.

Investors should be asking more questions like these two above, rather than the four at the beginning of this article. Our goal shouldn’t be to predicting where the market will be tomorrow; our goal should be to meet our investment objectives. We have very little control over the direction of the market, but we have total control of our strategy and the ‘healthy’ habits that will help us get there.