Investment advisors brace for these moments in the markets. The stock market erases the year’s gains. The phone starts ringing. It’s time to do some hand-holding.
Which is fine. It’s a financial advisor’s job to be the rock in a high tide and to help long-term investors see beyond the headlines.
Advisors spend a lot of time explaining what to do when stock markets slide. Yet it can be summed up in a single word — “nothing.”
That’s right, nothing. If you are properly invested on a Tuesday when the market is at an all-time high, you are still properly invested the next Friday when it has lost hundreds of points.
Warren Buffett has talked about this phenomenon at length over the years. He cites his mentor, the late Benjamin Graham, who tells the story of Mr. Market.
In Graham’s story, you are a business owner. Your equal partner is a wildly unsettled fellow named Mr. Market.
When sales and profits are up, Mr. Market values the business very highly. He’ll never sell. Never! You can offer to buy him out all day, every day and he won’t hear of it.
When the opposite occurs, as you can imagine, Mr. Market is ready to liquidate. He begs you to take his half of the business at any price. ask a vet free . Pennies on the dollar, please just let him out.
As Buffett explains, the stock market is your fictional partner, Mr. Market. At some points during a given week, month or year, things are going great and he’d never sell. Then a reversal comes and he can’t wait to cash out.
As Graham explained, the stock market is a voting machine in the short term but a weighing machine in the long term. Opinions of the value of the companies that comprise the market can move wildly in the short run.
But, over time, the true value of the companies in the index is apparent. The data over the very long term suggests that stock valuations go up at about twice the rate of economic growth. That’s largely thanks to reinvestment of dividends.
The other major point to make is that money begets money. If you earn a competitive market return and fail to panic and sell when prices decline, you can be relatively assured that your money will compound, that is, it will double in value as time passes. And double again.
Whether that’s in a few years or more than a decade is a function of how much stock exposure you can tolerate and your ability to stay in the markets as they go up and down in the short run.
But compound it does, ultimately leading to powerful wealth creation and the ability to ignore Mr. Market with confidence. What would Warren Buffett do in a stock correction? Mostly, nothing.
It’s really that simple.