How to bulletproof financial plans & combat emotional reactions to stock market volatility

This blog has been in existence for over 5 years. To my surprise, most of these posts I have published have been written by me exclusively. I have only published a few guest blog posts. While I still have some really great ideas to share with readers, featuring other personal finance and FIRE bloggers is a great idea to provide readers of this blog different perspectives. Therefore, for today I’d like to feature an article from A Purple Life.

A Purple Life is a fellow FIRE blogger from Seattle. She is tracking to retire by 2020 at age 30. I’m very excited to have her talking about her experience combating emotional reactions to stock market volatility. Remember, your ego is not your amigo!

Take it away A Purple Life! 

Thanks Bob. So, my Mom is not a poster child for the label of an early retiree. She retired almost 5 years ago at the age of 55 without having heard the term financial independence let alone “FIRE” (financial independence/retire early). She retired at 55 after watching her parents retire at 50. 

Retiring With Bonds And A Pension

As is the case with a lot of advice, it is not always accurate across generations. My grandparents retired from the military with a solid pension and savings that had been invested in CDs. They favored savings bonds and told my mother to invest in them while holding a lot of money in bank savings accounts. I must admit I have at times daydreamed of the days when CDs and regular savings accounts returned 9% instead of 0.25%.

So when my grandparents told my Mom to pay off her credit cards each month and only invest in savings bonds, she followed their advice. Unfortunately only half of that advice was going to help her retire early in the world she grew up in. As a result of this advice, my Mom didn’t invest in stocks AT ALL until she was 40 years old (high fives to anyone who might think 40 is a late start in our wild “I’m retiring at 30” world – it’s never too late)! 

 

Being A Stock Market Skeptic

My Mom was always wary of the stock market – and for good reason. There seemed to be little rhyme or reason to it. I too was very confused by it and the random gyrations of the market until I read this blog post by Jim Collins, which was later incorporated into his book The Simple Path To Wealth

He explained the stock market in a way I could understand: with beer. He said that the stock market is like a beer that someone else has poured for you in a mug you cannot see into. You don’t know how they poured it and as a result you don’t know how much beer versus foam is in it. That’s the stock market. 

The beer is the actual operating businesses within the market that are fighting to improve their products and expand their market share while the foam is the random vacillation of the market that’s driven by people frantically buying and selling while trying to beat the market by listening to experts on television who constantly contradict each other. 

Letting Fear Hold You Back

My Mom wasn’t prepared to deal with the foam. This is the part of the market that scared her because though she logically understood why the market overall will continue to march upwards over time, the daily, weekly, monthly and yearly fluctuations didn’t sit well with her.

It was this fear that led her to sell during the 2001 Tech Bubble AND the 2008 Great Recession to lock in her losses. It was this fear that led her to pay several financial advisors exorbitant fees for sub-par performance until only a few years ago. It’s this fear that makes her cover her ears when I mention how the market is doing – until I learned to just not mention it in her presence. 

After learning all of this and witnessing her reaction to market fluctuations, I knew that I needed another approach. Unlike her, I didn’t want to use a financial advisor and preferred to DIY my investments, which required well…actually looking at them.

 

Listening To Sketchy Financial Advisors 

I invested for the first time right out of college. During my first job at an ad agency in Manhattan, they slapped a welcome packet on my desk – it happened to contain a 401(k) registration form among other things. I asked my Mom what I should do and she gave me the number of her financial advisor (*cue a time traveling eye roll*). 

He told me to put my investments in a target date retirement fund. The conversation took about 5 seconds and it sounded like he was driving at the time so obviously he was taking my future retirement savings seriously (insert sarcasm here). He didn’t ask me anything about fees, loads or really any hard numbers. I took his advice and promptly forgot about my contributions while I fought my way through several jobs and promotions. 

 

Accepting Financial Independence

In late 2014, after nagging me for years, my partner finally convinced me to look into this “financial independence” thing he had been talking about. After reading the blogs he recommended with an open mind, I was hooked and dove in with both feet. I looked at my investments for the first time since choosing a plan based on that chat with a financial advisor years ago.

It turns out despite sub-par returns and a gross back-end load that I wouldn’t find out about until later, setting a fairly small percentage of my salary aside into my 401(k) amassed almost $50,000. WHAT?! At the time I had only a few thousand to my name otherwise. I was shocked. I had just witnessed firsthand the power of compound interest and the long term stock market. 

 

10 Years To Retirement

So I dove in further – I devoured every blog and book I could about investing. I moved my money to low cost index funds with Vanguard and I kicked my parents’ financial advisor to the curb. I educated myself about my finances and prioritized saving. Despite living a lavish life in Manhattan, I calculated that if I wanted to I could save enough to retire in 10 years. My retirement timeline had been created. All I had to do was keep saving and be patient. 

This newfound interest in my finances had another (at the time unknown) benefit. Because of my excitement, I checked on my money daily. At first, I told myself maybe I should check how the market is doing that day or week and then decide if I would check my investments or decide to wait, but then I realized: that would just give these fluctuating numbers on a screen power over me – the same kind of power they have over my Mom. 

 

What Do Stock Market Dips Really Mean?

No one ‘loses’ anything in the stock market until they sell. I believe it was Warren Buffet who said that when the market drops, he doesn’t look at what all of his stocks will sell for at that exact moment because he’s not selling all of his stocks at that moment. Instead he checks to see that he has the same number of shares as yesterday, which of course he does. 

Nothing has been ‘lost’ and stock market drops only affect your portfolio if you sell during them. Further, it is not a common situation to sell your entire investment portfolio at once so why would how much it would sell for on a random day matter? (Hint: It doesn’t).

On the opposite side of the coin, stock market drops aren’t just a temporary decrease in an index’s value, but also a sale on those stocks. Investment manager Cullen Roche hit the nail on the head when he said “The stock market is the only market where things go on sale and all the customers run out of the store.” There are many negative repercussions of a full on recession, but a dip in stocks for someone who is buying regardless can help turbocharge your path to financial independence. 

 

Embracing Exposure Therapy

So I decided to check my portfolio regardless of what the market was doing. I check my investments on a daily basis and during my 5 years on the path to financial independence I have faced a number of month to month stock market decreases. During these dips, I have observed something interesting that I’ll illustrate by describing my first reaction after seeing my portfolio has decreased each time:

2014

Net Worth: $48,562

1 Month Portfolio Decrease: -2.1% or -$1,373.77

My Reaction: “Huh – my portfolio is down a month’s (Manhattan) rent.” *shrug*

2105

Net Worth: $89,450

1 Month Portfolio Decrease: -5.19% or -$5,286

My Reaction: “That’s a quarter of what I spend in a year. Oh well. Let’s see if it comes back.” (Spoiler: It did)

2016

Net Worth: $137,612

1 Month Portfolio Decrease: -5.82% or -$8,009

My Reaction: “That’s more than I spent on that wild (though discounted) First Class Emirates ticket to the Maldives.”

2017

Net Worth: $234,822

1 Month Portfolio Decrease: (2017 didn’t have any monthly decreases 😉 )

My Reaction: “Weird – some months I’m making more money in the stock market than I am at my day job…”

2018

Net Worth: $280,884

1 Month Portfolio Decrease: -9.38% or -$14,333

My Reaction: “Interesting – that’s almost how much I spent in all of 2018.” (If you’re interested, I actually wrote about my reaction in real time on Instagram here.)

I assume you’ve noticed the weird part of this. Despite slowly seeing these dip amounts increasing as a result of my net worth growing, my reaction to these fluctuations has stayed shockingly neutral despite mentally translating what those large amounts of money mean in relation to my annual spending and my life.

I have yet to feel that drop in my stomach and sense of panic that my Mom has described when she watched her portfolio decrease in the past – the type of reaction that leads to panic selling and locking in your losses. 

I have a number of theories for why this is. When my portfolio decreases I know I haven’t lost anything – I have the same number of shares as the day before and I own the same amount of these companies that I did yesterday. In essence, nothing has changed. 

I also know that there are very few situations where I would need to liquidate my entire portfolio at once so the amount someone would pay me for all of it on a specific day is irrelevant. Further, my spending needs are so low and fluid because of the flexibility I have by not owning a car or a house that I can adapt no matter what the market is doing. For example, in retirement when I’m relying on my portfolio I can spend 3 months on a beach in Mexico or Thailand and enjoy my current standard of living with a much lower price tag if necessary (Yea for Geo-Arbitrage!). Therefore, the current state of the market has no real effect on my everyday life. 

 

But What If I Still Freak Out?

Every one’s situation is different. I am lucky that the life I enjoy has a lot of built in flexibility and levers I can pull to decrease my expenses, but I know that is not the case for everyone. 

In case you find yourself having an emotional reaction to stock market declines, what originally worked for me, before I put myself through years of exposure therapy, was to internalize that seeing your portfolio decline is not the same as losing money. You have not lost anything until you sell. Those big scary red numbers have no real effect on your current life (That’s why it’s important to ask yourself these 3 key questions before investing). 

However, if this mental exercise does not work and trying exposure therapy causes you a lot of negative emotions that makes your fingers hover over the “sell” button then you might need to adopt my Mom’s strategy: Just don’t look. No advice is one size fits all and if you need another approach that is perfectly fine. After you’ve identified that you just need to put blockers in place to keep you from pushing that sell button, such as a fee based advisor or a detailed investment plan that you have to stick to no matter what. 

 

Final Thoughts

So despite watching my net worth grow from $5,000 after college to $375,713 as of this writing and seeing the amount I ‘lose’ during dips similarly increase, I have yet to have an emotional reaction. Even seeing the big, negative, red numbers in my investment account some months doesn’t pull my heartstrings. I have no emotional attachment to those numbers. I am emotionally bulletproof to market fluctuations.

Allowing myself to watch these dips over time seems to have built up a tolerance. Not giving red numbers on a screen power over my emotions has allowed me to train myself to see temporary decreases as what they are: temporary blips that have no impact on my everyday life. 

To further strengthen my resolve as I near retirement, I’m planning to create an Investor Policy Statement of sorts that details what I will do in every investing situation I can think of. I am creating this just in case in the future, if I do have an emotional reaction, I will have a logical plan to follow. But for now I’m just going to ride my neutral reaction to market fluctuations that I’ve built up through exposure therapy until I retire at 30 next year. Let’s see what happens!

What do you think? Do you practice exposure therapy? How do you keep yourself thinking logically while investing in the stock market?

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27 thoughts on “How to bulletproof financial plans & combat emotional reactions to stock market volatility”

  1. This is an important post to read at this current time. I think we are going to see some big market swings over the next year with trade wars happening in the US, federal election in Canada and of course the crazy market roller coaster of oil. A good time to put the practices of this post to work.

    Reply
    • Haha – I don’t think I’ve ever been called a cool cucumber! That’s amazing. As for adding that to my Patreon I think I’d get horrible reviews because when my friends text me about the market I copy/paste a canned response: “If you can’t handle it either don’t look or don’t invest.” I have a tough love approach after fielding the same texts from them for years and responding with books and articles and facts…which didn’t work 🙂 .

      Reply
  2. This is something every index investor should drill into their brains: “No one ‘loses’ anything in the stock market until they sell.”

    Well said Purple! Great article with excellent insights for everyone—especially if we do hit another recession/bear market.

    Reply
  3. 2008-09 was pretty rough as a newer investor. i didn’t buy our first stocks until 2006 so thankfully the pot wasn’t too big yet but 60% down was really something even for our relatively small amount. it’s better to learn these lessons with a smaller amount in relative youth i think. now nothing rattles us as we just keep matriculating the ball down the field. i do raise our cash amount every year as we get older, though.

    Reply
    • Yeah 08/09 looked really rough. It’s great to hear a similar approach has worked for y’all and that you’re un-rattle-able now! As for increasing your cash holdings – that’s very interesting. Are you increasing your cash allocation for a specific reason or is that helping decrease your rattle-ability?

      Reply
      • we increase cash slightly by % as a kind of rebalancing. i want the cash percentage higher as we get older and have already made most of what we need to make. we’re only 6 and 11 years from social security age so that annuity is coming fairly soon.

        if i was still 25-30 i would probably only keep cash in the emergency fund and to save for vacations.

        Reply
  4. “I have the same number of shares as the day before and I own the same amount of these companies that I did yesterday.” – This is a really hard thing for people to grasp, and even if they grasp it, live by it.

    Reply
  5. Your mother’s reactions to the stock market are all too familiar to me – my parents always used to tell me that the stock market was “too risky” to get involved with. I was recently describing to my mom the tax benefits of maxing my 401(k), and she had never even considered it. Needless to say, neither of my parents grew up in families where investing was a regular topic of conversation, if at all.

    I feel fortunate to have, like you, discovered investing at a relatively early age. I don’t feel emotional about potential down-swings. Part of the reason is that we’re focused on saving cash right now so that in the event the market really takes a dive so we can go all in when the market is down. However, I do think my feelings would be a lot different were I planning to retire in the very near future. One useful reminder is the knowledge that early retirement is a luxury, but not an absolute necessity. If we needed to supplement our income for a while in retirement, I have no problem working more to do so. But I do like your idea- why not find a cheap beach town and live on next to nothing (and maybe some coconuts) for a few years!

    Reply
    • We’re definitely fortunate and I know that despite the mistakes my Mom did make she’s the reason I felt comfortable enough to even dip my toe into investing in the first place. Completely agree that early retirement is a luxury – in fact given the state of savings in the US, regular retirement is starting to seem like a luxury to me as well. Great perspective – I also have no problem making money if things aren’t looking good in my first 5-10 years of retirement to combat sequence of returns risk. I think I’ll try out my coconuts on the beach plan first though 😉 . Thanks so much for commenting!

      Reply
  6. A great article to be read very timely. Thanks for sharing.

    I look at my portfolio almost daily as I still need to invest more money now I am not retired yet. On big up/down day I am like “My portfolio gained/lost more than my family’s one month expense. ” I am not as calm but not panic yet. Who knows, I am pretty new to this game. Hopefully I will never cut meat on the floor.

    What helps me is not focusing at the portfolio size, but the investment income. I am a DGI investor and drippng, so my shares of stock increases every month no matter what the market status. It’s really calming to look at my expected investment income increasing. Actually, when market is down, I sometimes get more shares and my investment income increases even faster. So my mental game is trying to look at the portfolio size in an up day and the investment income in a down day. Is this cheating? LOL.

    Reply
    • Not cheating at all. Our portfolio value goes up and down quite a bit on volatile days and I’ve learned to not react too much with the day-to-day portfolio change. 🙂

      Reply
    • Happy you enjoyed it! And that’s an interesting point about investment income – I’m not a DGI investor, but that is an interesting perspective to look at investments through. I don’t think it’s cheating either!

      Reply
  7. Great article! I look at market daily and also have conditioned myself to ignore the daily fluctuations. What truly helped me was when I created a chart of one of my long term quality holdings (20 Years) and saw how the dividend had grown and price had grown. Think of all the bad things that have happened globally and the gyrations of the market over 20 years. I am also a DGI investor and love watching dividends grow. Got a raise this week!

    Reply
    • Congratulations on your raise! So glad you liked the article. A chart of long term holdings is a great idea – I might try that too! I’m always after new ways to combat our strange psychology.

      Reply
  8. Hi Purple Life. The difference is that your Mom actually lived and invested through a market correction. You have not. She perhaps watched her money/life savings get cut in half. But not sure when she bailed. Her reaction was typical.

    Thing is, you would not really know your tolerance for risk without going through a serious stock market correction. As I’ve penned on Seeking Alpha many times, the stock market has only given us a few love taps in the last decade. Those are kind and friendly warning shots.

    With that boxing analogy a few love taps is a completely different world to getting beat up quite badly and that anxiety that comes with losing that fight and you’re still getting pounded. You get knocked to the ground by Mike Tyson, ha, and you get up a couple to times, knowing he’s gonna hit you hard again, for real. And you can’t really see as your eyes are puffy and closed shut.

    Sorry that’s graphic. But that’s what a real stock market correction feels like. It is about how it feels.

    On Twitter I’m at @67Dodge I posted a stock returns chart by year and an article link.

    Dale

    Reply
    • Fair point. I haven’t gone through a serious correction yet, but I suspect that seeing how much my Mom regrets selling in a downturn and how much money she lost as a result would help me not repeat her mistakes. This is a guess and we shall see when the next recession happens.

      Reply

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