Father Flood, counseling recent Irish immigrant Eilis Lacey in the movie "Brooklyn," tells her "Homesickness is like most sicknesses. It will pass." The stock market is sick, and like most sicknesses, it will pass.
But there are several different treatments for this illness and it is important to understand which treatments will work best for you. Let's go through your symptoms and prescribe a course of action. Here are some things to evaluate in a diagnosis:
The blood tests and work-up results would be hard data. In investing, it is things such as time horizon, expected future contributions, asset allocation and withdrawal needs. But no good doctor can simply look at test results; they also have to understand how you respond to your situation. This is where in investing, the soft data of how you react to gains and losses, what kind of lifestyle you desire, and how impulsive you are impacts the diagnosis.
At the most basic level, being invested in stocks as compared with cash or bonds, will give you the highest returns with the most volatility. While diversification will reduce ups and downs, it will not eliminate it. If you have a long time horizon (over 10 years) and your regular contributions to your investments are significant when compared with the money that you have accumulated so far, the prescription is a significant exposure to a diversified portfolio of stocks (most likely through mutual funds). Make sure that your regular contributions also go into stocks. As a way to control the soft data — your abject horror as your investments drop — I suggest not opening your statements. In other words, take two aspirin and call me in a decade.
If the stock market is causing you to lose sleep, the diagnosis becomes far more difficult because of trade-offs. In today's political climate, this concept seems to be incomprehensible, but let's take a stab at it. If you are far more concerned about losing money than you are about making money, then you can reduce your exposure to stocks. The trade-off is that you will need to save more money to reach your long-term goals because your returns will be worse. This prescription is spend less today and spend less tomorrow.
A question to ask, though, is whether you have Munchausen Syndrome (where you act like you're sick even if you aren't). If you are invested appropriately given your time horizon and income needs, why would you torture yourself with daily market activity? Not only is this an illness of your own creation, the prognosis for your future will probably look far darker.
Generally, you may not know how you will react to falling markets until you have experienced them. One thing our firm has noticed is that people who are most upset when not fully participating in a stock market upswing (which diversification often causes) are also the most anxious when markets fall (even though diversification reduces the drop). These investors may have an incurable case of regret. It isn't terminal, but it is chronic.
Managing a chronic illness like this involves a treatment plan that has no guarantee of success, because emotion can override reason. This is what you need to do: First, establish the purpose of your investing. Your money is eventually going to be spent or given away, so you want to understand where you want to end up and recognize that it is a windy road rather than a straight line. Second, determine whether you are spending your money on the things that matter most to you. If you are spending at a level that is reasonable for your resources, you will have a much easier time replacing those resources later in life. Third, be realistic. No one has a magic potion that will create returns in all environments. Any investment that works really well in bad markets will not work as well in good ones; and vice versa. A promise of the opposite is snake oil.
