If it weren't for the fact that it represents real wealth, it would be nothing short of fascinating how the market reflects its human participants – in all of our enterprising glory as well as all of our quirky behavioral foibles, including herd mentality. Thursday, July 31st, provided a picture-perfect illustration of the latter, in which a run of trades begat a larger run of trades for what The Wall Street Journal referred to as "no single catalyst for the stumble." That's a fancy way of explaining the panic by saying, "Who knows?" The global news hasn't really changed all that much. All of the social, political and economic promises and threats that existed yesterday still exist in approximately equal measure at this time. There have been no asteroid crashes. So why is it that the market, in its collective wisdom, chose July 31 to stage a significant decline?
Even a brief scan of the financial news headlines yields any number of plausible explanations and a plethora of predictions on what is to come next. The truth is, we don't know. Nobody knows. Whatever is about to unfold – or not – does not change our recommended strategy for your investments.
We know it can be painful and hard, but market drops also serve as excellent, real-life illustrations of an important investing principle: Withstanding market risk when it actually appears is easier said than done.
There are several problems to the alternative of succumbing to herd mentality and reacting to the bad news with active trades:
- By the time you're aware of good or bad news, the rest of the market knows it too, and already has incorporated it into existing prices
- It's unexpected news that alters future pricing, and by definition, the unexpected is impossible to predict
- Any trades, whether they work or not, cost real money
Rather than try to play an expensive game based on information over which we have little control, we continue to recommend investing according to market factors that we can expect to control, such as:
- Minimizing costs
- Forming an investment plan to guide your way – and sticking with that plan
- Capturing returns available by participating in expected long-term market growth
- Maintaining diversified holdings to dampen market risks
Enjoy these final summer days!